The behavior of the stock market over the next 10 years will depend, not merely on the economy’s real rate of growth — which should develop at a rate somewhere between the average of 3.9 per cent for 1956-66 and the average 2.7 per cent for 1966-76 — but also on corporations’ ability to adjust to inflation. U.S. corporations have already made great strides in recognizing and adjusting to inflation, and that adjustment will continue for the next three to five years, as inflation subsides from its current rate of 10 per cent to a 10-year expected average of six to seven percent.
If the real rate of growth does develop as expected, and if inflation eases, corporate profits could expand at an average rate of nine to 11 per cent over the next decade. Higher payout ratios, running somewhere between 43 and 47 per cent, will generate dividend increases at the rate of 10 to 11.5 per cent per annum.
Acknowledging that small changes in his assumptions can have enormous impact on the final outcome, the author estimates that the S&P 400 will be in the neighborhood of 340 in 1988 (roughly equivalent to 2400 on the Dow), making for a corresponding rate of return for the 10-year interval of 17 per cent. If this estimate comes to pass, the most basic tenet of investment theory — greater reward for greater risk taken — will again be fulfilled.