(a) A $10 investment in 1800 in stocks would be worth $76 million, yes $76 million, today. This is a compound return of 7.9 %.

(b) A $10 investment in 1800 in bonds would be worth $209,000 today. This is a compound return of 4.8 %. Yes, equities outperformed bonds by roughly 350 fold.

(c) The difference of 3.1 percentage points is the so-called equity premium for stocks.

(d) Despite the 2007-08 Bear Market, the S&P since 1965 is up 38 fold which translates to a 8.7% compounded return.

(e) The Power of Compounding is the Eighth Natural Wonder of the World. 

(f) All of the above.

(a) The growth of GDP per capita is equal to rate of growth of productivity + inflation.

(b) The yield on the two-year Treasury bond is roughly equal to productivity + inflation.

(c) The growth of the earnings of the S&P 500 is roughly equal to productivity + inflation which is equal to the growth of GDP per capita which, in turn, is also equal to the yield of the two-year Treasury bond.

(d) Stocks need to return more than bonds because they are more volatile and riskier.

(e) The difference between the return on stock and bonds is the dividend yield (and stock buybacks) which compensates for the higher risk and volatility.

(f) All of the above.

(a) Productivity is the number one driver of the real gains in the stock market.

(b) No other variable or set of variables even comes close in importance.

(c) Increases in Productivity drive both the real earnings growth and the ability of companies to generate extra cash which can be paid out in dividends or stock buybacks.

(d) Until the Industrial Revolution, the gains in productivity were miniscule or non-existent. There were centuries with absolutely no gains in productivity.

(e) Productivity increases in this country began at about one-half percent per year and have steadily risen where today they are better than 2.5 % per year. The average family in real terms in this country is 86 times, yes 86 times, better off than its 1776 counterpart.

(f) The most important driver of Productivity is the body of technical knowledge which is growing exponentially due to the power of computers and the Internet.

(g) The outlook for Productivity has never been brighter.

(h) All of the above.

(a) False

(b) True

(a) Fees matter greatly in generating net performance. Although the reasoning is counter intuitive, smart guys do not outperform dumb guys due to efficiency of the market. If there were smart and dumb guys who had differences in performance, it would be just as valuable to find the dumb guys and do just the opposite of their recommendations. As it turns out, you cannot find the smart guys and you cannot find the dumb guys. This notion conforms to the Weak Form of Efficient Market Hypothesis which states in part that all stocks are properly priced relative to each other.

(b) The portfolio implication from Statement (a) is to use low-cost Index funds.

(c) Picking individual stocks is difficult because to be successful on an individual stock, you have to 1) know the opinion of the crowd, 2) have an opinion different from the crowd, and 3) be right. Hitting this Trifecta with consistency is extremely difficult.

(e) Over a sufficiently long time period, only 13% of all fund managers equal or beat the averages; this means that 87% of the managers fail to keep up with the averages. And nobody knows ahead of time which the lucky 13% will be.

(f) Trying to pick individual stocks for performance is an Expensive Fool’s Errand.

(g) All of the above.

6. Which of the following statements is true regarding the Peer-Group Trap?

(a) The vast majority of us enjoy the safety and security of our peer group.

(b) Like a committee, peer groups operate on the basis of consensus. Due to the time it takes to build a consensus, a peer group or a committee is rarely an early adopter.

(c) Long term, the stock market is driven by productivity, and viewed from a distance, the long-term returns look smooth.

(d) The long-term trend is really a series of connected medium-term cycles that are anything but smooth. All of these cycles have two things in common: first, they all have a beginning, an end, and another beginning; and second, each cycle is composed of Five Stages: The Base, Explosive Growth, Celebration, The Stall, and Look-out Below.

(e) The specific stage of the current market can be determined by a combination of Valuation Metrics, the News Cycle and the Market’s reaction to the news. Each stage of the stock market requires a different stock/bond mix.

(f) Since groups and committees are anything but early adopters, and since the stock market is a forward-looking discounting mechanism, the peer group is almost always one stage behind the stock market. This produces much less than an optimum return.

(g) All of the above.

If you successfully selected all of the last answers to each of these questions, send us your name and email address and we will send you a diploma which attests to your MSMU – your Masters in Stock Market Understanding.

HEW: 5-04-09