Why investing SS in the stock market is a horrible idea.

[Toro]

It doesn't state that human investors are risk-anything. (Finance tries to avoid actual biology as much as possible) However - the market operates in a way that makes it appear the players are - on average - risk neutral.




MPT doesn't say anything about what the correct expected return of the market overall is - as I've pointed out - this is a parameter required by MPT, not a parameter that MPT computes.



To put the absurdity of relying on past returns to predict future returns, take a look at SPY returns for the past year:

SPDR S&P 500 ETF Chart - Yahoo! Finance



If you look at it, you'll see lots of ups and down - but the clear overall trend is upward. The total increase is a little over 20%. There is a period of decline - during the fall of 2012 - but the prices recover and the market is again at pre-decline levels by February.

So based on this evidence, we should be able to conclude that although the price of the S&P 500 goes up and down, over any period that is at least 6 months long, it will at least retain its value, and on average, it will return 20%. Although we're only looking at one year of data - we can stagger 6 month samples so that we have as many samples as we like - and we could make a nice chart that shows the odds of winning or losing X dollars over certain intervals - and using all that, we should be able to convince people, like yourself, that the S&P 500 will always retain its value over 6 month periods.


Now do you see how absurd it is to base your expected 30 year return on barely more than 3X30 years of data? That's only 50% better than basing your expected 6 month return on a years worth of data, is it?

In fact if you look at the stock chart from a single day of a stock that did well on that day, you might conclude - using your method of reasoning - that the stock will go up and down but always retain or beat its value over 1 hour periods.

That's like saying "How do we know Western society works? We only have 200 years of data?" Perhaps we should crawl through the wormhole and measure the infinite multiverses, then we will have enough statistical data to see if the foundations of Western society are real.

If financial markets operate as if they are risk neutral, then why aren't the average returns the risk-free rate?

As for the past predicting the future, I do not believe that markets are efficient all the time, but I do believe they are efficient over long periods of time. In an efficient market, higher risk assets should earn more than lower risk assets over long periods of time. That's what theory says and that's what has happened in the past. Both theory and history tell us that those with long time frames are compensated for taking on risk. Thus, we should invest SS in the stock market like other pension funds and insurance companies, as do other national retirement schemes like in Europe and Canada.

The past 1 year of history has shown that 6 month periods the S&P 500 doesn't lose value. Do you dispute this claim?

If financial markets operate as if they are risk neutral, then why aren't the average returns the risk-free rate?

 

[OohPooPahDoo]

That investors are not risk neutral, that they have to be compensated for taking risks.

Compensated by whom?

By the growth in the economy.

No - by what people? And why would these people want to compensate the investors for taking those risks?

 

[Toro]

Compensated by whom?

By the growth in the economy.

No - by what people? And why would these people want to compensate the investors for taking those risks?

Everyone.

Because by compensating them for taking the risk, they benefit also.

 

[OohPooPahDoo]

That's like saying "How do we know Western society works? We only have 200 years of data?" Perhaps we should crawl through the wormhole and measure the infinite multiverses, then we will have enough statistical data to see if the foundations of Western society are real.

If financial markets operate as if they are risk neutral, then why aren't the average returns the risk-free rate?

As for the past predicting the future, I do not believe that markets are efficient all the time, but I do believe they are efficient over long periods of time. In an efficient market, higher risk assets should earn more than lower risk assets over long periods of time. That's what theory says and that's what has happened in the past. Both theory and history tell us that those with long time frames are compensated for taking on risk. Thus, we should invest SS in the stock market like other pension funds and insurance companies, as do other national retirement schemes like in Europe and Canada.

The past 1 year of history has shown that 6 month periods the S&P 500 doesn't lose value. Do you dispute this claim?

If financial markets operate as if they are risk neutral, then why aren't the average returns the risk-free rate?

That's the question that can't be entirely answered.


What I can say is that calculating an expected premium based on only the past 100 years or so of U.S. returns is plain absurd. Take a look at them:

http://stockcharts.com/freecharts/historical/images/djia1900s.png

Almost all of the gains that have been long lasting happen during TWO periods of exceptional economic growth - late 40's through the mid 60's, and the mid 80's through 2000. The entire calculated return over the entire 100 year sample essentially comes from these two 15-20 year secular bull markets. Thus to conclude that the average 30 year return in the future will be the same as the past 100 years requires not only that we presume the same frequency of these massive bull markets but that presume they happen close enough together.

Basing expectations on what will come in any given future 30 year slices of this ~110 year graph really is just as absurd as basing expectations of what will come in any given future 30 second slice on a 2 minute graph.



So while there probably is a real premium, you are overstating it by using U.S. stock market data for the past 100 years. The premium that does exist I think has to do with the risk-seeking behavior of companies raising cash through stock sales -

AND the fact that stocks are basically correlated to one another to some degree.

Let's put it this way - if stocks were in no way correlated to each other's movements - arbitrage becomes possible. You simply have to buy enough of them and the odds all cancel out and all you get is the average return. This would drive up their prices to the risk free return level. But stocks are correlated to each other's movements and there is only one global economy. If there were a race of space alien arbitrageurs that could invest in any planet's economy they chose - and if all the planet's economies were otherwise not connected - then the aliens would simply invest in all of the economies they can and the volatilities cancel out and with their buying they would drive up the prices (and probably price the natives out of the market who, not being able to invest in the intergalactic economy themselves, wouldn't want to take the risk anymore)

So one reason the stock market doesn't conform to risk-neutral valuation is that the market as a whole moves together (that's another thing I hate about modern investment advice - diversification is definitely good but it doesn't get you as far as you'd think. There is just ONE global economy and if you buy stock anywhere in it you're exposed to it.

 

[OohPooPahDoo]

By the growth in the economy.

No - by what people? And why would these people want to compensate the investors for taking those risks?

Everyone.

Because by compensating them for taking the risk, they benefit also.

Everyone? I haven't paid any investors for taking risks. Who is the "they" here?

 

[Toro]

No - by what people? And why would these people want to compensate the investors for taking those risks?

Everyone.

Because by compensating them for taking the risk, they benefit also.

Everyone? I haven't paid any investors for taking risks. Who is the "they" here?

You, me and everyone else benefits by the investments people make to grow the productive capacity of the economy. Because equity owners take the most risk, they earn the most reward.

Don't confuse that with the price of equities.

Attached is a logarithmic graph of the real return of equities with dividends reinvested since 1871. It comes from Robert Shiller's website. You can download the data and recreate it.

As you can see, the real return of stocks over time has been much more constant than a price index unadjusted for inflation.

 

[OohPooPahDoo]

Everyone.

Because by compensating them for taking the risk, they benefit also.

Everyone? I haven't paid any investors for taking risks. Who is the "they" here?

You, me and everyone else benefits by the investments people make to grow the productive capacity of the economy. Because equity owners take the most risk, they earn the most reward.

Where does the reward come from? Who actually pays for it? That's the profit I pay above costs at the store for milk? Would that mean milk would be worth more if it comes from a company with greater risk?

Don't confuse that with the price of equities.

Attached is a logarithmic graph of the real return of equities with dividends reinvested since 1871. It comes from Robert Shiller's website. You can download the data and recreate it.

As you can see, the real return of stocks over time has been much more constant than a price index unadjusted for inflation.

Did you actually get that from Shiller's website? It looks fishy to me.

 

[Toro]

The past 1 year of history has shown that 6 month periods the S&P 500 doesn't lose value. Do you dispute this claim?

If financial markets operate as if they are risk neutral, then why aren't the average returns the risk-free rate?

That's the question that can't be entirely answered.


What I can say is that calculating an expected premium based on only the past 100 years or so of U.S. returns is plain absurd. Take a look at them:

http://stockcharts.com/freecharts/historical/images/djia1900s.png

Almost all of the gains that have been long lasting happen during TWO periods of exceptional economic growth - late 40's through the mid 60's, and the mid 80's through 2000. The entire calculated return over the entire 100 year sample essentially comes from these two 15-20 year secular bull markets. Thus to conclude that the average 30 year return in the future will be the same as the past 100 years requires not only that we presume the same frequency of these massive bull markets but that presume they happen close enough together.

Basing expectations on what will come in any given future 30 year slices of this ~110 year graph really is just as absurd as basing expectations of what will come in any given future 30 second slice on a 2 minute graph.



So while there probably is a real premium, you are overstating it by using U.S. stock market data for the past 100 years. The premium that does exist I think has to do with the risk-seeking behavior of companies raising cash through stock sales -

AND the fact that stocks are basically correlated to one another to some degree.

Let's put it this way - if stocks were in no way correlated to each other's movements - arbitrage becomes possible. You simply have to buy enough of them and the odds all cancel out and all you get is the average return. This would drive up their prices to the risk free return level. But stocks are correlated to each other's movements and there is only one global economy. If there were a race of space alien arbitrageurs that could invest in any planet's economy they chose - and if all the planet's economies were otherwise not connected - then the aliens would simply invest in all of the economies they can and the volatilities cancel out and with their buying they would drive up the prices (and probably price the natives out of the market who, not being able to invest in the intergalactic economy themselves, wouldn't want to take the risk anymore)

So one reason the stock market doesn't conform to risk-neutral valuation is that the market as a whole moves together (that's another thing I hate about modern investment advice - diversification is definitely good but it doesn't get you as far as you'd think. There is just ONE global economy and if you buy stock anywhere in it you're exposed to it.

- there is no perfect arbitrage
- volatility doesn't entirely explain risk
- people are not always rational

Equity is compensated because it is the riskiest slice of the capital stack. If the total return on assets is 6%, and the right hand side of the balance sheet is composed of collateralized debt and equity, the collateralized debt will earn a lower return than 6% because it has first claim on assets and the return is fixed and more certain, while the equity will earn a higher return than 6% because the return is much less certain and more volatile. There can be no risk-free rate in the entire economy because investors - both creditors and equity owners - have to take risks to compensate them for investing.

 

[Toro]

Where does the reward come from? Who actually pays for it? That's the profit I pay above costs at the store for milk? Would that mean milk would be worth more if it comes from a company with greater risk?

The reward comes from increasing the productive capacity of the economy. It comes from figuring out how to bottle and sell the milk in the first place.

Did you actually get that from Shiller's website? It looks fishy to me.

It looks fishy to you because I just made it, and my excel skills suck on a Mac. Here is the website.

Online Data - Robert Shiller

Scale the real index price, adjust the real dividend to monthly and add it to the index, then multiply this to accumulated monthly figures over time.

 

[FactFinder]

Why investing SS in the stock market is a horrible idea.


Well, first thought is " One should not place all one's eggs in one basket." Second thought is: Do you really trust a 'pack of wolves'?

 

[Toro]

Ok, that graph looked especially fishy because it was! This is why one shouldn't be making graphs on a Friday evening when drinking scotch!

This is the graph of Shiller's real S&P 500 with dividends reinvested. That looks better.

Since 1871, the stock market has had three negative decades, 1910s (-17%), the 1970s (-13%) and the 2000s (-27%). Conversely, there have been seven decades when the stock market has doubled.

Edit - And FTR, the Dow Jones Industrial Average is a poor stock market index. It's a price index of a handful of stocks weighted by price, as opposed to the S&P 500 or Russell 3000 which are broad-market indices weighted by market capitalization. IIRC, the Dow has lagged the S&P 500 by about 1% a year over time. Nor does it include dividends. A pension fund will reinvest its income back into the fund, so when calculating the return from equities, we have to include dividends reinvested. Over time, dividends have returned about 4%. So dividends must also be included when calculating the return from equities.

 

[OohPooPahDoo]

Where does the reward come from? Who actually pays for it? That's the profit I pay above costs at the store for milk? Would that mean milk would be worth more if it comes from a company with greater risk?

The reward comes from increasing the productive capacity of the economy. It comes from figuring out how to bottle and sell the milk in the first place.

There has to be money that is transferred from one party to another in this process. Where is it? When I buy a bottle of milk I consider what the value of that milk is to me - I don't really care what financial risks were taken to get it to me. If milk Vendor A had to take 10X greater risks to get the same quality bottle of milk to me as Vendor B - I'm not going to pay Vendor A any more for his milk. So if the extra risk compensation money isn't coming from me - the consumer - where does it come from?

 

[OohPooPahDoo]

Ok, that graph looked especially fishy because it was! This is why one shouldn't be making graphs on a Friday evening when drinking scotch!

This is the graph of Shiller's real S&P 500 with dividends reinvested. That looks better.

Since 1871, the stock market has had three negative decades, 1910s (-17%), the 1970s (-13%) and the 2000s (-27%). Conversely, there have been seven decades when the stock market has doubled.

Edit - And FTR, the Dow Jones Industrial Average is a poor stock market index. It's a price index of a handful of stocks weighted by price, as opposed to the S&P 500 or Russell 3000 which are broad-market indices weighted by market capitalization. IIRC, the Dow has lagged the S&P 500 by about 1% a year over time. Nor does it include dividends. A pension fund will reinvest its income back into the fund, so when calculating the return from equities, we have to include dividends reinvested. Over time, dividends have returned about 4%. So dividends must also be included when calculating the return from equities.

I agree that the DOW jones is a poor index. This is the problem with doing real return analysis back as far as 1871:

1) the S&P 500 only goes back to 1957.
2) The Dow only goes back to 1885 - and its a really shoddy index capturing only a tiny portion of the market and subject to the selection bias of those that choose its components
3) Prior to 1885 we have crap - severe selection bias comes into making retroactive indexes because the more successful and more heavily traded companies will be more likely to be found by a historian.
4) We don't have good inflation index data prior to 1913 - its not possible to reliably compute real returns without good and meaningful inflation data.


I would submit that going back before 1913 on real return analysis is almost useless. Almost all of the upward movement in total returns since 1913 has occurred in 3 big jumps - the 20's, late 40's - early 60's - and mid 80's through 2000. These were all periods of exceptional growth. I don't dispute that we will have periods of exceptional growth in the future - but for 30 year returns to always be as good as they have been in the past 100 years requires these periods of exceptional growth to be spaced in a way that you get a big chunk of at least one of them during that 30 year period. It would be quite exceptional if the timings of these bull markets continued to happen just in time to either give people larger than usual nest eggs to start with for retirement or to catapult their mediocre savings into more substantial savings in the years just before retirement. We are bound to hit long 50-100 year period where these bull markets do not happen (and conversely bound to have 50-100 year periods where they happen all the time) - and the generation that misses one of these bull markets will suffer greatly in their retirements and at great expense to all, and the financial advisors who repeated the 30 year return mantra like it was infallible divine truth will be to blame.

 

[Toro]

Where does the reward come from? Who actually pays for it? That's the profit I pay above costs at the store for milk? Would that mean milk would be worth more if it comes from a company with greater risk?

The reward comes from increasing the productive capacity of the economy. It comes from figuring out how to bottle and sell the milk in the first place.

There has to be money that is transferred from one party to another in this process. Where is it? When I buy a bottle of milk I consider what the value of that milk is to me - I don't really care what financial risks were taken to get it to me. If milk Vendor A had to take 10X greater risks to get the same quality bottle of milk to me as Vendor B - I'm not going to pay Vendor A any more for his milk. So if the extra risk compensation money isn't coming from me - the consumer - where does it come from?

You look at it in aggregate. Vendor A may go out of business and Vendor B may make a fortune. But in aggregate, there will be industry profit and a return on equity to compensate the owners of the businesses in that industry for investing in the economy. Then there will be other industries that will be completely new and create value through investment in other ways. The productive capacity of the economy will grow and investors in businesses will earn a return. The profits generated by the assets will parceled out depending where investors are in the capital structure.

 

[Toro]

Ok, that graph looked especially fishy because it was! This is why one shouldn't be making graphs on a Friday evening when drinking scotch!

This is the graph of Shiller's real S&P 500 with dividends reinvested. That looks better.

Since 1871, the stock market has had three negative decades, 1910s (-17%), the 1970s (-13%) and the 2000s (-27%). Conversely, there have been seven decades when the stock market has doubled.

Edit - And FTR, the Dow Jones Industrial Average is a poor stock market index. It's a price index of a handful of stocks weighted by price, as opposed to the S&P 500 or Russell 3000 which are broad-market indices weighted by market capitalization. IIRC, the Dow has lagged the S&P 500 by about 1% a year over time. Nor does it include dividends. A pension fund will reinvest its income back into the fund, so when calculating the return from equities, we have to include dividends reinvested. Over time, dividends have returned about 4%. So dividends must also be included when calculating the return from equities.

I agree that the DOW jones is a poor index. This is the problem with doing real return analysis back as far as 1871:

1) the S&P 500 only goes back to 1957.
2) The Dow only goes back to 1885 - and its a really shoddy index capturing only a tiny portion of the market and subject to the selection bias of those that choose its components
3) Prior to 1885 we have crap - severe selection bias comes into making retroactive indexes because the more successful and more heavily traded companies will be more likely to be found by a historian.
4) We don't have good inflation index data prior to 1913 - its not possible to reliably compute real returns without good and meaningful inflation data.


I would submit that going back before 1913 on real return analysis is almost useless. Almost all of the upward movement in total returns since 1913 has occurred in 3 big jumps - the 20's, late 40's - early 60's - and mid 80's through 2000. These were all periods of exceptional growth. I don't dispute that we will have periods of exceptional growth in the future - but for 30 year returns to always be as good as they have been in the past 100 years requires these periods of exceptional growth to be spaced in a way that you get a big chunk of at least one of them during that 30 year period. It would be quite exceptional if the timings of these bull markets continued to happen just in time to either give people larger than usual nest eggs to start with for retirement or to catapult their mediocre savings into more substantial savings in the years just before retirement. We are bound to hit long 50-100 year period where these bull markets do not happen (and conversely bound to have 50-100 year periods where they happen all the time) - and the generation that misses one of these bull markets will suffer greatly in their retirements and at great expense to all, and the financial advisors who repeated the 30 year return mantra like it was infallible divine truth will be to blame.

I don't necessarily believe that 30 year returns will always look like the same as they have in the past. Nor would I necessarily recommend individuals always and everywhere invest in stocks with a 30 year time frame. Mostly I would, but not always. It depends on where assets are valued. That's why you have a well diversified portfolio of stocks, bonds, real estate, etc.

But I do believe, and history has borne this out, that a rising economy will lift asset prices, and rising profits will accrue to business owners in conjunction with a rising economy, thus lifting equity prices. It would be extremely difficult for over a very long period of time for all the gains that accrue to assets to go towards debt holders, which is in effect what you are arguing if you say the economy will keep growing but equities will do poorly over long periods of time.

 

[Toro]

Of course, one can take this logic from equities to all other asset classes. How do we know bonds will not lose all value in the future? How about real estate falling by 60%? How do we know taxpayers are going to want to continue funding SS? How do we know the US is even going to exist 100 years from now?

If we take the "The past can't predict the future" argument to its logical extreme, we have no idea about anything in the future and thus we shouldn't even have SS.

 

[OohPooPahDoo]

The reward comes from increasing the productive capacity of the economy. It comes from figuring out how to bottle and sell the milk in the first place.

There has to be money that is transferred from one party to another in this process. Where is it? When I buy a bottle of milk I consider what the value of that milk is to me - I don't really care what financial risks were taken to get it to me. If milk Vendor A had to take 10X greater risks to get the same quality bottle of milk to me as Vendor B - I'm not going to pay Vendor A any more for his milk. So if the extra risk compensation money isn't coming from me - the consumer - where does it come from?

You look at it in aggregate. Vendor A may go out of business and Vendor B may make a fortune. But in aggregate, there will be industry profit and a return on equity to compensate the owners of the businesses in that industry for investing in the economy. Then there will be other industries that will be completely new and create value through investment in other ways. The productive capacity of the economy will grow and investors in businesses will earn a return. The profits generated by the assets will parceled out depending where investors are in the capital structure.

Yeah, but who pays the investors their risk premium and when and why do they pay them?

 

[OohPooPahDoo]

Ok, that graph looked especially fishy because it was! This is why one shouldn't be making graphs on a Friday evening when drinking scotch!

This is the graph of Shiller's real S&P 500 with dividends reinvested. That looks better.

Since 1871, the stock market has had three negative decades, 1910s (-17%), the 1970s (-13%) and the 2000s (-27%). Conversely, there have been seven decades when the stock market has doubled.

Edit - And FTR, the Dow Jones Industrial Average is a poor stock market index. It's a price index of a handful of stocks weighted by price, as opposed to the S&P 500 or Russell 3000 which are broad-market indices weighted by market capitalization. IIRC, the Dow has lagged the S&P 500 by about 1% a year over time. Nor does it include dividends. A pension fund will reinvest its income back into the fund, so when calculating the return from equities, we have to include dividends reinvested. Over time, dividends have returned about 4%. So dividends must also be included when calculating the return from equities.

I agree that the DOW jones is a poor index. This is the problem with doing real return analysis back as far as 1871:

1) the S&P 500 only goes back to 1957.
2) The Dow only goes back to 1885 - and its a really shoddy index capturing only a tiny portion of the market and subject to the selection bias of those that choose its components
3) Prior to 1885 we have crap - severe selection bias comes into making retroactive indexes because the more successful and more heavily traded companies will be more likely to be found by a historian.
4) We don't have good inflation index data prior to 1913 - its not possible to reliably compute real returns without good and meaningful inflation data.


I would submit that going back before 1913 on real return analysis is almost useless. Almost all of the upward movement in total returns since 1913 has occurred in 3 big jumps - the 20's, late 40's - early 60's - and mid 80's through 2000. These were all periods of exceptional growth. I don't dispute that we will have periods of exceptional growth in the future - but for 30 year returns to always be as good as they have been in the past 100 years requires these periods of exceptional growth to be spaced in a way that you get a big chunk of at least one of them during that 30 year period. It would be quite exceptional if the timings of these bull markets continued to happen just in time to either give people larger than usual nest eggs to start with for retirement or to catapult their mediocre savings into more substantial savings in the years just before retirement. We are bound to hit long 50-100 year period where these bull markets do not happen (and conversely bound to have 50-100 year periods where they happen all the time) - and the generation that misses one of these bull markets will suffer greatly in their retirements and at great expense to all, and the financial advisors who repeated the 30 year return mantra like it was infallible divine truth will be to blame.

I don't necessarily believe that 30 year returns will always look like the same as they have in the past. Nor would I necessarily recommend individuals always and everywhere invest in stocks with a 30 year time frame. Mostly I would, but not always. It depends on where assets are valued. That's why you have a well diversified portfolio of stocks, bonds, real estate, etc.

What is "etc." ?

That's the trouble with the diversification myth. Its usually stated as "diversification means stocks, bonds, real estate, etc." and there is no explanation of the etc. First of - stocks and real estate together aren't really that diverse, as the past economic collapse should show you. In fact, if you can find any point in time when the stock market crashed and real estate values remained the same or went up - or vice versa - I'd love to read about it (not saying such a time never existed, just that it would be surprising). Second off - the phrase use to be "stocks, bonds, etc" - then real estate got popular - then it became "stocks, bonds, real estate, etc". Diversification really means "stocks, bonds, whatever is popular to invest in, etc".

Another huge problem with the diversification myth is the idea that simply having varied assets protects you from loss while haven't non-varied assets exposes you to loss. This isn't the case. Take two portfolios:

Portfolio A)

Equal amounts of exposure to:

S&P 500
corn futures
bit coins
debt of the Mexican government
a worldwide small cap mutual fund
U.S. Treasuries


Portfolio B)

1) long position on Microsoft
2) a put option to sell Microsoft at 90% of what I bought it for


Now which portfolio is more diverse? Clearly Portfolio A! Which is safer from loss? Clearly, Portfolio B!

But I do believe, and history has borne this out, that a rising economy will lift asset prices, and rising profits will accrue to business owners in conjunction with a rising economy, thus lifting equity prices.

That's true but I didn't argue otherwise.

It would be extremely difficult for over a very long period of time for all the gains that accrue to assets to go towards debt holders, which is in effect what you are arguing if you say the economy will keep growing but equities will do poorly over long periods of time.

Except you're talking about gains that haven't happened yet. They don't have to accrue to anything if they don't happen. Stock prices are based on what profits investors believe will come in the future.


Business can continue to be profitable and at the same time the market might misjudge how profitable they will be. If it turns out Company A is 10X less profitable than the investors thought it would be, Company A is still profitable but its stock will probably drop about 10 fold unless investors think it will make a big turn around. Once the price drops, the P/E ratio becomes more sensible again and the company would appear to be "profitable" to a new investor.



I admit I'm still befuddled as to how a gain can "accrue to an asset" and actually be realized without someone having to pay money for it. I know you don't actually believe this - but from your statements thus far it would appear that you are trying to say that businesses just accrue gains without anyone actually having to pay for them - like there's some sort of accrual gremlins that come out when everyone is asleep, dropping risk premiums into the pockets of investors.

 

[OohPooPahDoo]

Of course, one can take this logic from equities to all other asset classes. How do we know bonds will not lose all value in the future?

We don't. Nothing I've said implies otherwise and recent history certainly shows us its a possibility. Are you saying bonds are unfairly priced given the risk of default?

How about real estate falling by 60%?

How about it?

How do we know taxpayers are going to want to continue funding SS?

We don't. I don't see how this means we should give a big taxpayer handout to current holders of stock.

How do we know the US is even going to exist 100 years from now?

We don't.

I'm not sure what your argument is. We don't know whether other things will happen in the future, thus we should proceed as if we know for a fact the stock market will return at least X over Y years all the time?

If we take the "The past can't predict the future" argument to its logical extreme, we have no idea about anything in the future and thus we shouldn't even have SS.

No offense, but to emphasize, I would hardly consider rejecting your argument that 3 non-overlapping samples are sufficient to predict future samples to be taking anything to the extreme.

 

[Toro]

There has to be money that is transferred from one party to another in this process. Where is it? When I buy a bottle of milk I consider what the value of that milk is to me - I don't really care what financial risks were taken to get it to me. If milk Vendor A had to take 10X greater risks to get the same quality bottle of milk to me as Vendor B - I'm not going to pay Vendor A any more for his milk. So if the extra risk compensation money isn't coming from me - the consumer - where does it come from?

You look at it in aggregate. Vendor A may go out of business and Vendor B may make a fortune. But in aggregate, there will be industry profit and a return on equity to compensate the owners of the businesses in that industry for investing in the economy. Then there will be other industries that will be completely new and create value through investment in other ways. The productive capacity of the economy will grow and investors in businesses will earn a return. The profits generated by the assets will parceled out depending where investors are in the capital structure.

Yeah, but who pays the investors their risk premium and when and why do they pay them?

As the economy grows, savings, i.e. the capital stock, also grows. The gains from the growth of the capital stock accrue to the owners of the capital stock, i.e. investors, savers. Investors are either lenders (debt holders) or owners (equity). Is it possible for the economy to grow over long periods of time without the capital stock growing? Possibly I suppose, but it seems highly improbable in our economy given the legal structures this society has afforded capital. I assume that you accept the economy grows and with it, so do savings. Thus, it appears that you are concerned with how the gains are distributed within the capital stack, and the price of the claims within the capital stack, i.e. the price of debt relative to equity. I don't know entirely. Neither do the academics. But I do know that if I am a lender with a claim on the collateral of the business who receives a fixed payment from the cash flows of the business, I will receive less than the owner of the business. I, as a lender, want the owner to make as much money as possible because the more money he makes, the more secure are my claims. Likewise, the less sure I am of his business prospects, the higher interest rate I will charge.