The supply of capital market returns is generated by the productivity of businesses in the real economy. The aggregate of market returns is then divided among various claimants, and is constrained by the amount supplied. GNP measures real economic performance, which determines the supply of returns, and is used in a simple model of the expected return on the aggregate of financial assets.
The supply side model can be used to forecast expected capital market returns. For instance, the real GNP growth rate over the two decades ending in 1982—2.6 per cent—may be projected forward and combined with current yield and new issue data to produce a forecast of 5.4 per cent per year for real return on the aggregate of financial assets.
The supply model places in perspective the various demand models that dominate thinking about investment returns. For instance, investors should not expect a much greater (or fear a much smaller) return than that provided by businesses in the real economy. Thus investors’ expectations should be guided at least in part by the supply of market returns.