How can long term stock market returns exceed long term GDP growth? If GDP is the sum of all goods and services produced within a country and the stock market is made up of many of the companies within the country, how can the value of those companies grow faster than the goods and services they produce? Is the answer in international growth? Productivity growth? Speculation?
The short answer is that the relationship between the economy and the financial markets is complex and poorly understood.
Because the stock market reflects the value of shares of the company stocks, which is not the same as the value of the products of those companies.
Stock market returns can, simply because the stock markets are just a subset of all capital markets. If you’re talking about all of the capital markets, then you’re correct in assuming that this is not sustainable. At the end of the day, total market returns and GDP growth have to converge in the long term.
The problem is that all stock market indices are just proxies for their market. Indices, whether broad or narrow, can never be a true measure of market performance. One glaring weakness is survivorship bias. For example, the S&P 500 and the Russell 3000 theoretically consist of the 500 and 3,000 largest companies in the US, respectively. Thus, they only contain the performance of companies that are successful enough to be in the index. The companies that went bankrupt or shrunk in size are removed. Thus, the index tosses the unsuccessful company out and replaces it with a successful one. But a true market index would also contain the performance of the smaller, unsuccessful companies.
Another issue is that companies listed in a particular country don’t necessarily operate in just their home country. They sell to domestic and foreign entities. They are supplied with domestic and foreign resources. The MSCI ACWI (All country world index) consists of every country weighted by market cap. But survivorship bias also affects the ACWI.
Posted too soon…
My last point is was that any relationship between GDP and market returns would have to be studied globally. This would eliminate the impact of varying inflation rates, government spending rates, global trade, etc.
This is key, but you failed to mention one of the clearest corollaries.
Total investment includes both stocks and bonds (and other debt), so if stocks are outperforming bonds, they will outperform “total investment” (which might roughly correlate with GDP growth.)
I think there are other important effects. Just to mentioon one: Increased foreign growth by U.S. companies would cause them to outperform U.S. GDP (at least if foreign companies weren’t making comparable inroads into U.S.)
This was exactly what I meant in my first line. And really, it’s not just stocks and bonds, but every single investment (real estate, private equity, private debt, etc.)
GDP includes the exports. It’s our output, not our consumption.
GDP = govt spending + private consumption + investment + exports - imports
As to the OP, part of it is survivorship bias and subsegment impacts as discussed. Another factor would be that GDP is basically a book valuation, while market prices are, well, market valuation. That is, stocks tend to be priced based on expected returns, via a discounted cash flow method - so assumptions about growth rates (and financing) are baked in. Additionally, under the Capital Asset Pricing Model, which is a big driver of pricing - you effectively have a one factor model, with Beta being the only driver of price. So, you end up pricing along what’s called a new efficient horizon after adjusting for risk free rates, with correlation to market movements beign the only determining factor of a stock’s price - effectively it’s reactiviness to business cycles. All idiosyncratic risk is ignored as being diversifiable and therefore unrewarded. So, as the risk profile of a given index moves, it’s value changes - but none of this really drives GDP.
It’s a question of forward looking measures vs. historical ones. You would think that they might tie over time, but there really is no reason for them to. Think about futures markets for currency - they are notoriously poor predictors of what currency exchange rates will be in the future.
You miss the point. McDonald’s makes hamburgers in Spain with Spanish workers and Spanish ingredients and sells those hamburgers to Spaniards. The main thing American here is where McDonald’s stock is traded. Stated differently, companies with foreign investments and operations partake of world-wide growth, not just U.S. growth.
I hope I don’t need to provide a cite that those Spanish hamburgers are not included in U.S. GDP! 
Just out of curiosity, have we ever had a period of say 20-30 years where stock market returns exceeded, on average, the average annual GDP?
My impression is that you have booms and busts in the market that tend to mirror the economic/business cycle. So while there may be periods where the market does better than the economy (eg, tech bubble), aren’t they canceled out to a great extent by the down periods?
This has been touched on, but to put a finer point on it, how would one account for the fact that many assets tend to move counter to one another? For example, when we are in a boom period, the Federal Reserve will tend to raise rates. This has the effect of causing capital losses to bond holders - either a paper loss or a realized loss if they sell before maturity. Other examples would be gold and to some extent Forex (although I’m convinced that the only successful Forex traders are the ones who have sold their souls to Satan).
GDP growth in U.S. averaged 3.4% (I read) during 1950-2000, much less than average stock return. (Some of the reasons why “stocks” outperform the economy have still not been touched on in this thread.)
(BTW, the silly “axiom” about long-term stock performance always being good should be qualified to specify past U.S. perfomance. The “axiom” is found to fail if applied to, e.g. early 20th-century performance of German stocks!)
I wouldn’t focus on the transitions for the “macro” view. (Periods of rising yields and falling yields offset in the long-run().) During booms with high interest rates, yields on debt are good! (This point is often overlooked: high rates of real interest are a good sign! Creditors are asking for high return because of high opportunities.)
( - Yes I know what J.M. Keynes said. :D)
Ah, yes, of course. And the growth of consumption of products made in the US by companies with foreign ownership would be shown in in US GDP growth and foreign market growth, but not in US market growth.
ETA: this point also raises a current issue, where growth in other countries is flat, but the US currency is sinking in relation to foreign currency, causign repatriation of cash to grow in US dollars, and stock prices to raise, without any actual growth at all