The paper studies the long-term trend of US stock market valuations, measured by the relationship between stock prices and dividends. This ratio, which shows a growing trend over the last hundred years, is decomposed into two factors: the expected value of future dividends and that of the returns on shares. A methodology is developed that allows us to quantify the relative contribution of each factor to the trend.
The rising trend in the price-to-dividend ratio is entirely attributable to the decline in expected equity market returns. This component can be further divided into a risk-free part, comparable to the natural interest rate, and a risk premium. The decline in expected returns is mainly attributable to the decline in the natural interest rate, in line with the results of the most recent literature on secular stagnation.
