Wednesday, May 4, 2011

Dow Two Million

The United Nations came out with a report yesterday indicating that it expects the world's population to top 10 billion by the end of this century. Reading the news reports got me thinking about the power of compound interest.

I don't view the United Nations report as necessarily gloomy. It really just reflects a very modest global population growth over the next century.

The world's population today is roughly 7 billion. Reaching 10 billion by 2100 implies a compound growth rate of just 0.40% per year for the next 89 years.

That said, this forecast has potentially a number of implications for our planet and our limited natural resources. Commodity prices, for example, will almost certainly be moving sharply higher unless we change the way we power our cars and feed ourselves.

From an investor's standpoint, population growth can also represent an opportunity, especially since historically demographics seem to play an important role in determining the longer term trend of capital markets.

Much of the forecasted population growth is expected to occur in Africa, where there are already numerous countries struggling to provide even the most basic needs of food and water. Large investments in food and infrastructure will be needed in many African countries.

Compounding even small increases over long period of time can lead to some fairly startling results. And while doomsayers since Malthus have projected that population growth will overwhelm mankind's ability to cope, I am optimistic that it is also possible that we will develop better ways to use our limited resources so that basic needs can be met.

For example, the great investor John Templeton used to say that he would not be surprised to see the Dow Jones Industrial average hit 2 million in the next century.

How did he come up with this? Well, historically, stocks have returned about 6% per year, not including dividends.

The Dow Jones Industrial Average today is trading around 12,700. If stocks follow the historic trend of the last century, a 6% compound growth rate for the next 89 years implies the Dow would be trading around 2,000,000.

U.N. Forecasts 10.1 Billion People by Century’s End -