What is The True Stock Market Price (Inflation Adjusted)?
With the recent Wall Street crash and recovery, howdoes the Stock Market compare? Where has the stock marketreally gone over the long run? Is the upward trendreally just an illusion based on inflation?
Adjusting stock market prices for inflation usingthe "Consumer Price Index" is known as the Stockprice in "real dollars". (A "real dollar" is the price after adjusting forinflation).
One of the worst problems with inflation is thatdistorts our perception... things are not always whatthey seem and this introduces uncertainty into our decisionmaking process.
Here are some hypothetical scenarios:
- The stock market went up 5% a year and inflationwent up 3%.
- The stock market went up 5% a year and inflationwent up 5%.
- The stock market went up 5% a year and inflationwent up 6%.
- The stock market went down 5%a year and inflation went up 2%.
In example #1 above inflation increased less thanthe stock market so the real return is 5% minus 3% soyou had a "real return" of 2% (before taxes and afterthe inflation adjustment).
In example #2 inflation increased the same as thestock market so the real return is 5% minus 5% so youbroke even (before taxes). But after paying taxes onthe phantom gain of 5% you will actually lose money.
In example #3 above inflation increased more thanthe stock market so the real return is 5% minus 6% soyou had a real loss of 1% (before taxes). But you willstill have to pay taxes on the 5% gain making your realloss even worse.
In example #4 you have a 5% loss on the stocks plusa 2% loss of purchasing power for a net loss of 7% butyou will be able to offset that somewhat by claimingthe stock loss on your taxes.
As you can see the only way to see the true pictureis to look at the inflation adjusted prices. Wehave created several other inflation adjusted pricecharts includingOil,Gold,Corn,Gasoline,Electricity,Mortgage Rates andEducation.
The most commonly mentioned methodto measure the stock market is the Dow JonesIndustrial average.
I have often wondered why this index is so widelyquoted by economic pundits, (other than the fact thatit was originally created on May 26, 1896, making itthe first index). At the time the DJIA represented theaverage of twelve stocks from various important Americanindustries. Today the "DOW" is made up of 30 "representative"stocks and it's composition has changed many times overthe last 100 plus years. Because the Dow takes out poorperforming stocks and replaces them with better performingones it has an inherent upward bias.
Rather than rely on "representative" stock indexesI prefer the real thing so I have created this "inflationadjusted stock price" chart by adjustingfor inflation on the entire New York Stock Exchange(NYSE). The NYSE has the largest dollar volume ofany stock exchange in the world. About 2,800companies, representing a market capitalization ofabout $18 trillion, are listed on the NYSE,so it gives us a much broader view of the stock marketthan any 12 or 20 or 30 stocks could. In addition byit's very nature it gives you an idea of how theaverage investor would perform. After all, howlikely is it that you will pick the top performingstocks without the benefit of hindsight? If you arean average investor it is likely that you will endup choosing stocks that will perform similar to theaverage of the entire market.
Plus with only 30 stocksa large move in any one of them could influence theentire DOW index. There have been days when Microsoft orWal-Mart alone have created a significant move in theindex even if all the other 29 stocks were doing nothing.
Historical Commentary:
Let's look at the stock market and see how it hasfared in real inflation adjusted dollars comparedto previous years.
As you can see from the above chart the blue lineshows the "nominal NYSE index" (meaning the actual pricequoted by the media). To get the "Inflation Adjusted"red line we adjust the stock price for inflation usingthe Consumer Price Index (CPI-U) which is typicallyreferred to as the "Inflation Rate". This gives us theprice in terms of modern dollars. In other words, thered line shows what the stock market would look likeif there was no such thing as inflation.
In nominal terms (blue line) the NYSE stock indexbegan 1966 just under 500. And by July of 1982 the nominalstock index had increased to 615 after having been evenhigher. So on the surface it would appear that the "stockmarket" posted an increase of roughly 23%. (615-500=115)and (115 ÷ 500=.23)
Now a 23% increase in 16 years would be a nominalincrease of 1.43% a year (less if you consider compounding)which doesn't sound that great, but in those days stockspaid higher dividends than they do today. So investorsexpected to get their profit from dividends rather thancapital appreciation. So most investors would be happywith a 23% increase in their stock portfolio over andabove their dividends.
The inflation adjusted stock price
However, when you adjust for the increase due toinflation, we can see from the red line (which is the"inflation adjusted NYSE Index stock price"in current dollars) that in inflation adjusted dollarsthe index began 1966 higher and actually fell 59% through July of1982.
So rather than a 23% increase, if you count inflationand had held stocks for the 16 years from 1966 to 1982,you would have actually lostabout 59% of yourpurchasing power due to inflation.
But to make matters worse you would have paidtaxes on your dividends and "paper gains" furtherreducing your final remainder. This may be onereason companies began reducing dividends, so moremoney was pumped into increasing the stock price andwasn't taxable until you actually sold.
Current Commentary:
In the time since 1982 the stock market hasincreased both in nominal terms and in inflationadjusted terms. In inflation adjusted terms the NYSEstock index is abovethe peak of 2000 (first dotted red line). The August 2000 stock peakoccurred at around 6800 in nominal terms or 9678 inSeptember 2017 inflationadjusted terms. Then it bottomed in April 2002.
The market peaked again in July of 2007 at12,072 ininflation adjusted September 2017 dollars. This resulted in a 24.7% increase in sevenyears from peak to peak or about 3.2% per year (compoundinterest). After the 2007 peak the market lost about50% of its value and then made a substantialrebound peaking again in 2014 at11,386 in inflationadjusted terms. But in inflation adjustedterms the NYSE did not exceed its 2007 highs. And in fact, fellbelow 2000 peak levels in January of 2016. Sofrom August 2000 to January 2016 the market wentexactly nowhere! (And that is using theofficial BLS inflation numbers, if inflation wasactually higher the market went less than nowhere itactually lost money!) Recently the market hasrebounded again and because inflation has been lowthe NYSE has exceeded the 2014 level and ten yearslater it has finally exceeded the 2007 peakin Inflation Adjusted terms!
On October 13th the NYSE closed at 12,352.Exceeding a previous peak is generallyconsidered a bullish signal. Currently theNYSE ROC is in HOLD territory.
Timing
OurNYSE - ROC (Rate of Change) chart tracks the nominalrate of change in the NYSE and gives an excellent visualpresentation of stock market nominal rates of returnthus making it easier to determine when you should bein the market and when you should be on the sidelines.
For more information on the effects of cumulativeinflation go toCumulative Inflation by Decade for a full description.
Inflation Indexed Bonds (i-Bonds) are supposed toprotect you from inflation while providing a reasonablereturn. How well have they done?
See OtherInflation Adjusted Prices:
- Historical Oil Prices Chart
- Annual Average Oil Prices in Table Form
- Inflation Adjusted Gasoline Prices
- Inflation Adjusted NYSE Stock Index
- Inflation Adjusted Price of Corn
- Inflation Adjusted College Education Costs
- Inflation Adjusted Price of Gold
- Real Mortgage Rates
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