charts: Dissecting Returns

Dissecting Returns

Financial Physics presents the interconnected relationships between certain factors in the economy and the resulting environment in the financial markets. This analysis dissects the components of Total Return and looks at the potential returns available for the rest of the decade. Without further, unsustainable increases in valuation (P/E ratios), returns will likely fall short of the historical average. If inflation remains below the historical average (near 3.5%), economic growth (GDP) and earnings growth (EPS) will also be below the historical average. Future returns from the stock market are likely to be muted if (1) inflation remains stable and earnings grow slowly or (2) if inflation increases and drives P/E ratios lower. Strong stock market returns over the rest of the decade can occur only if P/Es expand further — against the laws of Financial Physics.