The Golden Age of the Digital Revolution
We argue that this environment of uneasiness and uncertainty is what a long-term secular bull market should resemble. Fred Rogers and Richard Lalich in their 2014 book, Ride the Wave, How 12 Technologies will Change the World and Make You Rich, laid out the techno-economic trends expected to drive productivity and earnings growth for the next two decades, but most investors can’t see it.
The last financial crisis and continental divide in our political foundation are focusing minds on short-term worries that prevent the necessary euphoria and speculative risk-taking from materializing.But regardless of the perspective, as the chart below shows, the reality remains the same.
The orange box on the left represents the malaise that began after the market peaked in the mid-sixties with the maturing of the mass production revolution and the birth of the digital revolution.The upward sloping line from 1982 to 2000 represents the speculative “installation phase” of the digital revolution, in which the market rose dramatically.
The orange box on the right represents the transitional phase of the digital revolution when creative-destruction tears down then rebuilds key institutions. And finally, a new upward sloping market is emerging to the right that could easily match the 1982 to 2000 bull market regarding gains.
Ready for 65,000 on the Dow Jones Industrial Average?
In previous letters, we've explored how the Digital Revolution is transforming the economy. With better economic policies emphasizing the supply side―business creation, innovation and job growth―we think the economy will return to its longer-term growth rate of about 3.5%―the same speed the President's economic team has been evangelizing.
That means the economy will almost double in the next 20 years. Mckinsey's Bing Cao, Bing Jiang, and Tim Koller argued in 2013, much of the stock market’s performance is linked to real economic growth, including GDP growth, corporate profits, interest rates, and inflation—in spite of short-term volatility. And in the absence of some disruption of that link, the market should continue to compound growth.
Let's plug in the numbers.
1. Over the next 20 years, we assume we get long-term average GDP growth of 3.5%.
2. We'll use Mckinsey's real cost of capital of 7% which is about 10% including inflation.
3. Also, let's use the long-term inflation rate of 2.5%
4. We will also assume like many analysts that the stock market currently is overvalued by about 25%.
Using these assumptions, Mckinsey's market calculator predicts an 8.1% annual total return (including dividends) for twenty years. That equates to 5.6% annual price return (without dividends). With the S&P 500 Index at around 2,450 today the model predicts 7,300 in 2037. And with those assumptions, we can expect 65,000 on the Dow Jones Industrial Index ("Dow").