Growing Up

Is growth inevitable?

Photo: Skeeze. Source: Pixabay

There’s a common assumption about investing that growth just happens. All you have to do is put your money to work for a long enough time it will ultimately lift off – like a seedling planted in the ground. The combination of competition, commerce, and the free movement of capital is like sunshine, soil, and water. Eventually, a tiny seedling sprouts and grows into a giant redwood.

But markets aren’t magic. There’s no physical force of nature pushing them higher and higher. Diversification may reduce risk – the mathematics make that work. But stock market returns roughly follow economic growth. And the reason for that is clear as well. Stocks are a residual claim on corporate cash flow. Companies that don’t have enough internal growth opportunities return some of that cash to shareholders in dividends and stock purchases. As the residual claim, stocks benefit the most when an enterprise is successful

Source: World Bank, Bloomberg

If an economy grows more quickly, the opportunities for corporate growth are greater than if it grows slowly. The stock market isn’t a talisman that spins straw into gold. Competition and commerce are a sorting mechanism that winnows out good ideas – ideas that improve our lives and make us more productive, like John Deere’s steel plow or Thomas Edison’s lightbulb or Steve Jobs’ iPhone. The benefits from these innovations redound to their shareholders. And when there’s more economic growth, there’s more benefit to be had.

But don’t get complacent. The market is very inconsiderate: it doesn’t produce returns just because we need them. But a rising economic tide lifts all our investment boats. Just don’t take growth for granted. What may seem like an economic miracle could turn out to be a mirage.

Mirage in Mojave Desert. Photo: Broken Inaglory. Source: Wikipedia

Douglas R. Tengdin, CFA

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