THE SECULAR MOVEMENT OF the U.S. stock market in the postwar period
has been characterized by three distinct twenty-year episodes of sustained
increases or decreases in real stock prices: the bull market of 1945–66, the
subsequent bear market of the 1970s and early 1980s, and the bull market
of the middle and late 1980s and the 1990s. Explanations of the most
recent and spectacular bull market have typically been based on several
factors:1 the advent of a “new economy” in which innovations create a
permanently higher rate of economic growth and an accompanying
increase in the intangible capital of the corporate sector;2 the substantial
increase in participation in the market; and the apparent decrease in risk
aversion of the baby-boom generation.3 Similar arguments, based on the
“new economy” created by the technical innovations of the immediate postwar period and increased participation in the stock market, have also
been used to justify the bull market of the 1950s.4 The period of declining
stock prices from 1966 to 1982 has spawned fewer rationales, as documented
by the well-known paper by Franco Modigliani and Richard
Cohn.5 They argued that real earnings and interest rates could not account
for the 50 percent decline in the real Standard and Poor’s (S&P) index
between 1966 and 1978, and they found themselves forced to conclude
that the only explanation for the sustained decrease in stock prices was
that investors, at least in the presence of unaccustomed and fluctuating
inflation, are unable to free themselves from certain forms of money illusion
and therefore look to the nominal rather than the real rate of interest
when valuing equity. Although these explanations probably capture
important elements underlying the behavior of stock prices in each of the
three episodes, they cannot readily be pieced together to form a coherent
explanation of the stock market over the whole sixty-year period.
