1.) Why do you stocks always go up in the long-term?
2.) If you could put $1 million into one sector? What sector would you put it in? (All the money must be put into one general section eg Financials, Tech, Real Estate etc). Why is this sector undervalued?
Would appreciate good responses to these questions.
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1) wellll copout answer - inflation :D 2) I'd put it into the government sector - they own everything - not sure they're undervalued though
Investors are risk averse, whereas stocks are risky. Therefore in order for investors to hold stocks instead of say a Treasury bond, they must receive a risk premium.
Energy Sector. Very briefly - natural inflation hedge, demand growth from emerging economies i.e. China, limited supply, uncertainty in the Middle East etc. etc.
Of course in a growth scenario (where most of the earnings are reinvested into the company), stock price will increases mainly because of growth.
The risk premium and required return should not change simply because of time. They will remain the same as long as there is no uncexpected inflation or change in the firm's risk characteristics.
Agree with macroguy here.
For #1 you can use inflation and because of this, over time equities have what is called an "upward drift".
2 I would also probably choose commodities (energy sector) because it is an inflation hedge and they are real assets that eventually get consumed, and will be in greater demand with emerging markets.
As far as I know, the risk premium should decrease over time as markets become more mature/stable and investor's therefore require a lower premium in order to invest. I.E. An emerging market should have a higher risk premium than a mature market.
ibdhopeful, you are right that the risk premium tends to decrease over time for emerging markets. However, this is a FINITE process since the risk premium cannot continue decreasing into infinity (obviously). The risk premium for emerging markets will decrease until it reaches an equilibrium point, similar to mature markets. This means that you cannot use a decreasing risk premium as the reason stocks "ALWAYS go up in the long-run" (since it's a finite process). Inflation, on the other hand, is the reason.
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