7 Reasons the Stock Market Will Go Up

We sometimes take the whole "the stock market goes up with time" thing for granted. If you think about it, continual growth requires an increasing supply of buyers...sounds an awful lot like a Ponzi scheme. But don't worry! Motley Fool Answers did some digging, and has seven reasons why the market is not a Ponzi scheme and will almost certainly continue to rise in the long term.

Alison Southwick and Robert Brokamp explain why inflation, population trends, productivity and more are boons of good fortune for the market. Also, remember the marshmallow test? Well, chances are pretty good that study was just a smidge unreliable, at least. Alison sets the record straight with some new data and analysis.

A full transcript follows the video.

This video was recorded on June 19, 2018.

Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined as always by Robert Brokamp, personal finance expert here at The Motley Fool. Hi, Bro!

Robert Brokamp: Hi, Alison!

Southwick: In today's episode, Bro's going to answer once and for all why we should believe the stock market will go up over the long haul.

Brokamp: Or should we?

Southwick: Wait, what? We didn't actually have a planning meeting, so I don't know what's going to happen.

Brokamp: We'll see! I'm just trying to build some suspense here.

Southwick: All I know is that I'm going to roast the marshmallow test. All that and maybe not so much more on this week's episode of Motley Fool Answers.

Brokamp: So, what's up, Alison?!

Southwick: Well, Bro, it turns out that we here at Motley Fool Answers are just as guilty as the next ... everyone when it comes to perpetuating the lies of the marshmallow test.

Brokamp: Yes, we have mentioned it once or twice.

Southwick: For roughly 30 years now, people have been trotting out the results of that test to show that being able to delay gratification as a child is a sign of future success. But, some scientists recently revisited the marshmallow test and came out to some different conclusions. 

First, let's revisit that marshmallow test. If it doesn't sound familiar to you, it will very quickly. A scientist named Walter Mischel developed this test back in the 60s at Stanford and published the results in the 90s. Many people have replicated it throughout the years just so they can laugh at little kids suffering. What did they do? They put a marshmallow in front of a little kid -- four years old, in fact -- and told them, "If you don't eat your marshmallow by the time I get back, you can have two marshmallows." If a kid passed the test, it meant that he or she waited, delayed gratification, and was rewarded with another marshmallow when the adult came back into the room. 

Researchers then checked back in on these kids as they grew up and they found that those who had delayed gratification went on to great success in life. They had higher SATs, they were physically healthier, all-around better. The kids who failed to delay gratification and ate that single marshmallow ... ended up being hobos, I don't know. The point is that the ones who ate the marshmallow apparently didn't achieve as much as adults, and obviously, being able to delay gratification at a younger age, even the young age of four, meant you were going to grow up to be an awesome adult.

So, when the results came out, NYU's Tyler Watts and UC Irvine's Greg Duncan and Hoanan Quan were skeptical. The original test, for example, was only conducted on 90 four year-olds who were enrolled at Stanford's preschool. So, perhaps not the most diverse group of kids -- affluent, highly educated parents.

With the new test, they gave it to almost a thousand kids from all over the country, much more racially and ethnically diverse. What they found was that kids from higher socioeconomic families had a 70% success rate on the marshmallow test. They didn't eat the marshmallow. Lower socioeconomic families had a 45% success rate. 

Then, though, they compared the results of kids from similar backgrounds -- ethnicity, gender, cognitive ability, etc. If these two kids looked very similar, but one of them ate the marshmallow and one of them didn't, was one going to end up being more successful in the future than the other one who had the similar background? The answer was no. If you basically had the same socioeconomic, same backgrounds, looked the same, had similar backgrounds and upbringings, you both were going to end up the same, regardless whether one of you ate the marshmallow or didn't eat the marshmallow.

The results challenged the idea that being able to delay gratification is baked in and will result in success. Instead, it's more likely a symptom of something else, like your socioeconomic factor. For example, if you are in a poor family where marshmallows are not abundant, or anything in general -- food, if you come from a home where the cupboard is often bare, there's no guarantee that there will be food in the future. And so, you need to get what you can now, because food is scarce. If you're from a wealthy family, where marshmallows are abundant -- and by marshmallows, I mean everything in life -- there's no reason for you to doubt what your parent is saying, that you'll have two more in the future. There's no reason for you to doubt that it will not rain marshmallows in your future, because it has rained marshmallows your whole life.

The Atlantic cited another study, one by Harvard economist Sendhil Mullainathan and the Princeton behavioral scientist Eldar Shafir. They wrote a book in 2013 called Scarcity: Why Having Too Little Means So Much. They talked about how poverty can lead people to opt for short-term rather than long-term rewards. They state that not being able to have enough can change the way that people think about what's available now. In other words, a second marshmallow seems irrelevant when a child has no reason to believe that the first one won't vanish at any moment anyways. 

There's a lot to dig into here, as far as causation and correlation. The bottom line is, the advice from these researchers is that while being able to delay gratification is a good trait -- they don't deny that -- it's not going to sink your future prospects, especially if you're just a four year-old looking at a marshmallow. There are other, much more important factors that are going to contribute to your future success. Eat the marshmallow, don't eat the marshmallow. The marshmallow is not the thing.

Bro, the stock market just keeps on going up!

Brokamp: It's a thing.

Southwick: I'm so excited. It's always going to go up, right? Isn't there a bias in behavioral finance, where you feel like if the stock market is going down, in your mind, you think it's always going to go down?

Brokamp: Right, the recency bias. You look at recent short-term experiences and you extrapolate that into the future. We all have a lot riding on the stock market. According to the Investment Company Institute, 65% of IRA assets are in stocks. That's also the allocation to stocks in the state pension plan, according to a 2017 report from Wilshire. Vanguard says, across all the 401-Ks that they administer, 73% of assets are in the stock market. The National Association of Stock Plan Professionals says that half of public employers provide equity compensation to their employees. Then, there are all the stocks that are held in college savings account, trust funds, annuities, and regular old brokerage accounts. So, we all have a lot riding on the stock market because it always goes up, right?

Southwick: Yeah, if you pull back far enough. If you don't zoom in too tight, yeah, it always goes up.

Brokamp: Yeah, exactly. Not every year. Maybe not even every decade. But it always reaches new heights. At least it has in the past, and if you're talking about the U.S. stock market. But every once in a while, I wonder, is it possible we have too much faith in the stock market?

Southwick: [laughs] You're such a curmudgeon!

Brokamp: I'm an awfulizer! [laughs] 

Southwick: You are! "Is it possible that things are just too good? Ugh, how can I make myself feel unstable and sad today? I know!"

Brokamp: Hear me out. When we talk about the past, we're looking at the historical data, which is, depending on your source, maybe 100 years, maybe 150 years old. But when you consider that modern humans have been around for like 40,000 years, that's a small sample size. You can go to the website of economist Robert Shiller, and he has data going back to 1872. But a lot has changed since Ulysses S Grant was president, so I'm not sure how much all of that data is relevant. 

Plus, let's not forget that the stock market is a true market. The price is set by buyers and sellers coming together and determining a price. The price of a stock doesn't go up just because it came out with a new drug or a new widget or expanded into China. A stock price goes up because there are more buyers than sellers. If a company doubled its profits overnight, but the next day there are more sellers than buyers, the stock price is going to go down. 

Really, what we're counting on is that in the future is, there are going to be all these many more buyers of the stock we need to sell when we need to pay for college or retire or something. And what's another name for something that requires an ever-growing stream of new buyers to be sustainable?

Southwick: It's a Ponzi scheme.

Brokamp: A Ponzi scheme, yes! Exactly!

Southwick: You heard it here first! Robert Brokamp says the stock market is one great, big Ponzi scheme! This has been Motley Fool Answers. We're done. Tom and David are going to come in here and literally pull the plug.

Brokamp: Well now, hold on. I was thinking about this the other day, I was literally walking my dogs, thinking about, are there fundamental reasons for why the stock market goes up? And, fortunately, a new article came up by Ben Carlson. Ben is with Ritholtz Wealth Management and has a blog called A Wealth Of Common Sense. He provided a couple of reasons for why the stock market goes up. I read his article, did a little other research. For this episode, I'm going to discuss some of the things that I learned and tell you why I still think the stock market will go up over time. The majority of my retirement assets are in the stock market. But, I do think it's just something to consider.

Southwick: [laughs] "But, there is an impending doom and Armageddon that I am fully ... We should still prepare for the end times," said resident awfulizer, Robert Brokamp.

Brokamp: [laughs] Alright, well, let's start with Ben's post, shall we?

Southwick: Yes.

Brokamp: Like many of these discussions, it begins with historical data. He provides some data from the Credit Suisse Global Investment Returns Yearbook. It looked at returns from 1900 to 2017, pretty long-term. 117 years, I don't know, is that enough? We'll see. Anyway, United States? 6.5% a year, after inflation. Throw in 3-3.5% for inflation, you get that 10% that people often hear about.

Southwick: On this show, in fact.

Brokamp: On this very show! That compares to 2% for bonds after inflation. So, stocks historically have outperformed bonds. That all sounds very good, but it's important to remember that we U.S. investors have had a pretty good time of it. Over the long-term, there have only been two other countries that have outperformed the U.S. Anyone want to take a guess? Anyone? Anyone? You won't be able to guess them. It's a challenge.

Southwick: That's quite a challenge. I'm going to say Uzbekistan --

Brokamp: No, it's not that.

Southwick: I'm trying to go as obscure as possible. And Djibouti.

Brokamp: No. No. 1 was South Africa, No. 2 was Australia.

Southwick: Oh, OK. I could buy that.

Brokamp: Yeah, you could have gotten there. When you take out the U.S., the world over that span of time returned 4.5% after inflation. 

But there are plenty of examples where things did not work out for a country. Japan is commonly cited as an example. First of all, there was World War II, where its stock market dropped something like 96%. The same thing happened in Germany, Austria, a lot of other countries. Its stock market now, the NIKKEI, is still down more than 40% from where it was in 1989. Back in the 1950s, Egypt's stock market was the fifth-biggest in the world. But then they turned socialist and the stock market closed down from 1961 to 1992. 

Then we look at the U.K.'s FTSE. The U.K.'s FTSE 100 hit $6,950 in 1999, just a little under $7,000. Just this past March, it dipped below that level. Now, it shot up to $7,700 since then, but we're still looking at not-all-that-impressive growth for a period of almost 20 years. Of course, you got dividends along the way, but still, a developed country, long-term holding period, not as much money as you might have expected. 

Still, when you look at the world average, stocks on the whole have made money and have outperformed bonds. Can we expect similar performance in the future? The answer is, I think yes. 

Southwick: As much as it pains you to say that. [laughs] 

Brokamp: [laughs] I'll give two reasons from Carlson's article, and then I'll add five others from my other research.

Southwick: There we go, alright.

Brokamp: Here we go. No. 1: you own a piece of a company. Carlson wrote, "The structural idea is that stocks offer a piece of ownership in corporations." This is something we've mentioned before on the show. Investopedia defines a stock as a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. 

I think that's a good place to start when understanding the benefits of stock ownership. But that doesn't mean -- like, I own shares of Home Depot. I can't go into Home Depot and just grab a hammer and not pay for it. And I only get cash from the company if it's paying dividends, which not every company does. Fortunately, most do. More than 400 companies in the S&P 500 pay dividends. Those are the big companies. When you get down to small-cap stocks, only about half pay dividends. So, most do. But they're not a guarantee. Companies can cut dividends. You're not guaranteed to get that money. Still, as companies grow more and they earn more money and pay more dividends, more investors will want a piece of that action and buy more shares. So, I think that's a good place to start.

The other reason that Carlson gave was that risk should lead to reward. He pointed out that, on the capital structure, bonds are ahead of stocks. If a company goes out of business, bondholders generally don't lose everything. They get a little bit back. And they have to pay their interest payment before they do anything else. You don't have any guarantee with stocks. If your company goes bankrupt, you've pretty much lost everything. 

If you were to look at a finance textbook, a theory about stock ownership, it's basically like, "You have to earn something for taking more risk. That's just built into the system." But for me, that's actually not that compelling of a reason, because the whole nature of risk is, you don't actually know what's going to happen. Still, I think it's important to recognize that, generally speaking, historically, risk has been rewarded. But, of the seven reasons for why I think it'll continue to happen, it's the least compelling.

Here's another reason: the economy grows over time. If you were to have someone like Warren Buffett in the room, this is one of the reasons he always cites for why the stock market will be a good investment. Generally speaking, the economy, especially the U.S. economy, will grow over time. In fact, in his 2016 letter, he wrote that American GDP per capita at the time of his letter was $56,000. That's 6X higher after inflation than when he was born in 1930. It just keeps growing. 

So, assuming that the economy keeps growing, companies will be worth more. Also, people will have more money, and they'll have more money to invest. That will address part of that question of "will there be enough buyers of stocks to keep prices going." I think that's a pretty compelling argument. Assuming that you believe that the economy will be higher ten, 20, 30 years from now, the stock market's a good investment.

Reason No. 4: inflation. There's actually a surprisingly high amount of debate about what causes inflation. We may remember that after the Great Recession, a lot of people were afraid of inflation because of all the government stimulus. Well, that didn't happen. But I think we can agree that inflation is partially due to the fact that companies try to charge higher prices and get away with it. Starbucks just raised its prices on coffee. Amazon Prime has gone up. Netflix raised prices toward the end of last year. Every company wants to try to raise prices if they can. Plus, it's built into the mandate of the Federal Reserve. They have a target of maintaining 2% inflation. If they don't hit that target, they stimulate the economy. If it gets too high, they might take some of that stimulus away. But it's built into our economy to have inflation.

If prices are going up, that generally means companies are making more money. That doesn't necessarily translate into higher profits, because companies have inputs as well, and those are going up, so they have to have pricing power and things like that. But I think it's one reason why you can expect sales and revenue to grow in the future. It's also a reason why I think investors will favor stocks over bonds. When you buy a bond -- like a five-year bond paying 3% every year -- you're automatically going to lose inflation. If you don't want to fall behind inflation, you're going to go to the stock market. I think that, again, also addresses some of the concerns about, will there be enough demand for stocks in the future.

Reason No. 5: demographics. The world keeps getting bigger. Depending on the source you consult, the world population doubles every 60-70 years. That means more people to buy the products that the companies are selling, which drives up revenue. It also means there are more people out there to buy stocks and to invest in the future. As long as there are more people in the world, generally speaking, the economy is going to grow. 

Now, when you read more deeply on this topic, you do get to a point where people ask, "Well, how much can the world grow? At what point does growth become unsustainable?" which I think is a long-term concern, probably more for our kids than for us. Eventually, I think that is a long-term concern. But for the foreseeable future --

Southwick: That's what Mars is for. We'll just worry about that later.

Brokamp: [laughs] We'll just rely on all of that.

Southwick: We're going to colonize ... we'll worry about that later.

Brokamp: No. 6: productivity. One of the more interesting articles I read about why the stock market goes up was by Chris Gillett, it was published on Medium. He suggested that technological progress was a big reason for the rise of the stock market. He created a fun little chart showing the relationship between the number of patents issued each year compared to the S&P 500. There's actually clearly a relationship there. As people become more inventive, go for more innovation, that does drive the economy and the stock market. Also, technological progress leads to productivity growth. In other words, getting more done with the same amount of time. Gillett sites research from Shawn Sprague, which found that from 1998 to 2013, there was no growth in the number of hours worked, but output grew 42%. That makes companies more valuable, obviously.

Then, the last reason, No. 7: survival of the fittest. When we talk about the stock market, we're talking about things like the S&P 500, maybe the Dow Total Stock Market. But we're talking, basically, companies that have made it beyond start-up status. If the stock market were made of every company ever started in the U.S., things would not look so good. According to the Small Business Administration, 30% of new businesses fail in the first two years, 50% in the first five, and only 25% make it beyond 15 years. If you're in the stock market, you've made it beyond that. The capital markets have decided you're worth being invested in, so you've gotten beyond that. You've already established yourself. You're going to be a good investment. 

Then, when you look at an index like the S&P 500, which is market-weighted, it means that as companies grow, they have a bigger influence on the performance. As a company shrinks, its influence shrinks, as well. It's sort of a built-in mechanism by basically rewarding the companies that are doing the best. You put that together, I think that's another reason why investing in a very broad index is probably a good strategy for the future. I think that's important to realize, because that's different than going out and picking five individual stocks that you like. The numbers clearly show that, actually, the average stock underperforms the market. 

One of the books we often cite here at The Motley Fool as one of our favorite investing books is One Up On Wall Street by Peter Lynch. Peter Lynch became famous by investing in the Fidelity Magellan fund. He left it in the early 90s. It has been a lousy fund since then. Today, the net asset value of that fund is still 24% below where it was in 1999. And that was a diversified mutual fund of U.S. companies. So, I do think it makes sense that, if you're going to invest long-term in the market, you have to establish yourself as a really good stock picker or at least have some of your money in a broad index so you can benefit from the overall growth of the stock market.

So, the bottom line here is, I think there are plenty of reasons to believe that the stock market will continue to rise over time. All of my retirement money is in the stock market. But I'm a good 20 years or so from retirement. I think, once I get within ten years, I'm going to start prying back. I think at that point in your life, it makes sense to lock in some gains.

As a closer, let's conclude with something that Ben Carlson closed his article with. He wrote, "In many ways, investing in the stock market is a faith-based exercise: faith in human ingenuity, faith in the capitalist system, and faith in other people wanting to improve their lot in life. For those who do take a leap of faith and understand the inherent riskiness of stocks, I do believe they will continue to offer investors higher expected returns."

Southwick: You wouldn't say, working at The Motley Fool, you have a little bit of a bias toward investing in the stock market? [laughs] 

Brokamp: I do have a bias. I was reading the Vanguard study. Every year, they come out with How America Saves, it's basically an analysis of all of the retirement accounts they have. As I said, 73% of assets in the stock market. They say 5% have just stocks. 

I think people here The Motley Fool, many Motley Fool readers and listeners, are very aggressive. I would say, I don't know about the majority, but a good percentage of people who are fans of The Motley Fool have all-stock portfolios. That's definitely my experience talking to them. I think I do have a bias toward being pretty aggressive and having a good amount of faith, despite my awfulizing, in the stock market.

Rick Engdahl: You don't sound aggressive.

Brokamp: [laughs] I'm just cautious! You know what I think is a big difference? It's a big difference between how I feel like I should lead my life and what I should tell people to do. I feel a greater responsibility to be very thoughtful about what I tell people to do. I mean, if I go 100% stocks and it drops 50% and I can't retire, big deal. It's my own life. But if I tell people to do that, I feel horrible.

Southwick: That's because you're good man.

Brokamp: Thanks!

Southwick: I want to say thanks to Brian and Emma, who sent a postcard from their honeymoon in Bora Bora! They have been listening to the show since day one, which is awesome! Sorry for those early episodes, but thanks for hanging in there.

Brokamp: [laughs] Three and a half years ago.

Southwick: It's crazy. Also, the reviews keep coming in on iTunes! ORD767FO, Snow, CJMcKenzie, ShastaBound, RedGar, gofiremomma, BrendanRohan, they all left some reviews. I also wanted to call out gofiremomma's. She wrote, "I love listening to Alison and Bro and their advice. I'm only 24, getting into investing and trying to become FIRE pretty early." And what does FIRE stand for?

Brokamp: Financial independence, retire early.

Southwick: "But, they talk a lot about taxes and maximizing your money when you eventually take it out. I also like that they talk about the best options for kids' college and education since I'm heading that way soon. Most of the things they teach me are hard to find online without hours of searching for things I never even knew existed and probably wouldn't find out about without this podcast."

Brokamp: Aw, that's nice!

Southwick: Bro, doing the digging and the research for you! So, I want to thank everyone for leaving reviews. It's awesome. It warms the cockles of our hearts, whatever that is.

Brokamp: I looked it up once. I can't remember what the answer was.

Southwick: Cool, Bro! [laughs] 

Engdahl: How could you look that up and not remember?

Southwick: Cool story, Bro! So, yeah, please keep the reviews coming. They make us happy. Also the postcards! Again, our address is 2000 Duke St, Alexandria, Virginia, 22314, care of Alison and Bro or Team Answers. Chances are, if it's a postcard from someplace, they'll know it's for us. 

The show is edited optimistically by Rick Engdahl. Our email is [email protected]. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody!