Week 31 Day 3: The Recovery Always Comes: 100 Years of Proof

If you could see a chart of the S&P 500 from 1926 to 2024, all those devastating crashes would look like minor dips on an overwhelming upward trajectory. From close up, each crash felt like the end of the world. From far away, they were temporary pauses in a steady march from $100 to over $1 million.

Why the market always recovers: (1) Corporate earnings grow over time. Companies innovate, cut costs, expand into new markets, and increase productivity. The best companies during the 2008 crisis (Apple, Amazon, Google) used the downturn to invest and emerged stronger. (2) Population and productivity growth. More people producing more goods and services means a bigger economic pie. Global GDP has grown at approximately 3% real for over a century. (3) Inflation pushes nominal prices higher. Even if real returns were zero (they are not), inflation alone would push stock prices upward over decades. (4) Central bank intervention. Since the 1930s, central banks have aggressively supported financial markets during crises (rate cuts, quantitative easing, emergency lending). This does not prevent crashes, but it accelerates recoveries. (5) Human resilience. People adapt, innovate, and rebuild. After every crisis, new industries emerge, new technologies develop, and the economy reorganizes around new growth drivers. What could prevent recovery? Two scenarios: (a) permanent destruction of the economic system (revolution, war on home soil) -- low probability in diversified democracies. (b) a multi-decade depression like Japan 1990-2010 -- possible but mitigated by global diversification (own VXUS alongside VTI).

The long-run positive trend in equity markets is theoretically grounded in the economy's production function: output = f(capital, labor, technology). All three inputs have grown secularly over the past century: capital stock increases through investment, labor grows through population growth and immigration, and technology improves through innovation. Total factor productivity (TFP) has grown at approximately 1-2% annually in developed economies since 1870 (Gordon, 2016). Combined with population growth (approximately 1% globally) and capital deepening, this produces nominal GDP growth of approximately 5-6% in developed economies. Since corporate earnings are a share of GDP (approximately 10-12%, fluctuating but mean-reverting per Kalecki's profit equation), earnings grow roughly in line with GDP. And since stock prices reflect discounted future earnings, stock prices trend upward with GDP growth, plus a dividend yield of approximately 2% for a total return of approximately 7-8% real. The Japanese counter-example (Nikkei 225 peak at 38,915 in 1989, not sustainably surpassed until 2024) demonstrates that individual country markets can stagnate for extended periods. Dimson, Marsh, and Staunton (2002) documented several other cases: Austrian stocks lost substantially during WWI, Russian stocks went to zero in 1917, and Chinese stocks went to zero in 1949. However, globally diversified portfolios have never experienced a negative real return over any 20-year period in the DMS dataset. The insurance against Japan-like stagnation is international diversification -- holding VTI + VXUS rather than VTI alone.