Stock Market's Total Return Outperforms Inflation by About 7% a Year

Bear with me on this one. The long-term evidence suggests that the stock market’s total return outperforms inflation by about 7% a year (or doubling in real terms every ten years). That’s of course an average—the stock market has been dead flat against inflation for 12 years now.

Here’s a look at the stock market’s real total return, meaning with dividends and adjusted for inflation, divided by a line rising at 7% a year. In other words, a flat line is a real increase of 7% a year.

Just to make things even weirder, I used a log scale. The idea is to get the purest measure of the stock market’s performance.

Since earnings growth tends to be fairly consistent, this line is surprisingly similar to a graph of price/earnings ratios. Of course, there’s no guarantee that stocks will continue to outperform inflation by 7% a year.

What I find interesting is that the peaks and valleys seem to line up well. Warning: It’s dangerous to see relationships where none may exist. Still, it’s kind of interesting. I think it’s also interesting to see that there are very long periods of out-performance and under-performance. Stock investing is hardly a game for all seasons.

Comments

[Dave Wrixon:]

Much depends on whether you give the US CPI any credibility or not.

It would seem that inflation was actually running much higher than stated during the Bush years, resulting in lower than prudent interest rates, which is exactly what has caused this mess.

To have any chance of making a road map out of here, the US needs to get it statistics sorted out. Otherwise it is like wandering around in the fog without a map or a compass.

May 03 09:05 AM

[Jimbo:]

The government has manipulated the CPI numbers in order to avoid cost escalation requirements, e.g. Social Security payments. This dishonesty is now catching up with us.

May 03 10:15 AM

[muguwmp:]

You are probably right that the CPI is understated. If I remember correctly, the rules used to measure the main urban CPI (there are a whole bunch of CPIs) were changed a few years ago because the federal government was spending too much on inflation subsidies for social security etc. If you look at the dollar against oil prices, you will see that during the Bush presidency, the Fed followed a continuous weak dollar policy from early 2002 all the way through mid-2008 when the S&P crashed and the recession-induced global flight to safety stopped the fall of the dollar. The dollar has rallied since then, but it’s only a matter of time until it resumes it’s downward trek. Nominal interest rates apear to have been kept lower than they should be. The fear of deflation dominates political thinking. Inflation makes it easier and cheaper to borrow.

Since oil is priced in dollars, the Fed’s policy contributed significantly to the bubble in US oil prices. It also was responsible in large measure for the bubble in housing and real estate prices, though legislative meddling via Freddie, Fannie and aggressive mortgage lenders also played a large role. The recession has been worse than it should have been due to misguided government intervention.

Now we are faced with a politically motivated misinterpretation of the 1935 Keynesian approach to business cycle management that is likely to accelerate inflationary expectations. The market was stagnant from mid-1966 through 1982, reflecting high inflation and unemployment all through that period, but the economy didn’t really begin to strengthen until Reagan’s second term. Also, it’s important to keep in mind the well-documented presidential cycle – recessions at the end of every presidential term – that has had an effect on stock market returns.

The Gingrich-Kasich-Clinton deal that produced such phenomenal growth from 1994 to 2000 ( with help from Greenspan’s easy money policy) took the S&P from 435 to 1492, an increase of roughly 243% or nearly 23% per year on average, plus dividends. That is 4 times the long-term 7% return mentioned, a performance so far out of the norm that it’s unlikely to be repeated anytime in the future. The market now appears to be adjusting to the long-term trend line but US and global growth should be below trend for several years. The baby boom generation is going into retirement, so the demographic pressures are different, and the computer revolution is maturing. I expect the 7% return to average out a bit below that until we get a better handle on whether and to what extent the build-up in federal debt levels will have on prices and employment over the next year or two.



On May 03 09:05 AM Dave Wrixon wrote:

> Much depends on whether you give the US CPI any credibility or not.
>
>
> It would seem that inflation was actually running much higher than
> stated during the Bush years, resulting in lower than prudent interest
> rates, which is exactly what has caused this mess.
>
> To have any chance of making a road map out of here, the US needs
> to get it statistics sorted out. Otherwise it is like wandering around
> in the fog without a map or a compass.

May 03 12:26 PM

[1.5 quadril...:]

There are long periods (1965 to 1983 for example) where all you make on stock is dividends and you have substantial capital risk. The reason firms like Goldman Sachs lobbied so hard for the Commodities Moderniztion Act of 2000 was that they couldn't make double digit returns any more, even in the short term. Strock as an inflation hedge were dead because INFLATION was the only thing driving them!

The DOW never got about 1000 between '65 and '83...that is a really LONG buy and hold for a retired income investor or even a DCA 401k investor.

Wake up and smell the propoganda....

May 03 03:55 PM

[Oh-Boy:]

Totally agree. Bonds have outperformed stock throughout my entire working career (1980 to present).


.

May 03 05:49 PM

[dcb:]

according to a recent article I read in the FT t-bonds would have outperformed stocks for about 40 years I believe.

Long View: Why baby boomers will put their faith in bonds

By John Authers

Published: March 6 2009 20:23 | Last updated: March 10 2009 12:53

These are bad days for the cult of the equity. The bare figures say it all.

As of mid-morning on Friday in New York, after the latest terrible US jobs data, the S&P 500 index was down 64.4 per cent in real terms from a peak that it set in 2000.
EDITOR’S CHOICE
Analysis: Investment and the crisis - Mar-02
Candover falls into private equity trap - Mar-02
BIS seeks warning signals of crises - Mar-02
Asean vies to find crisis response - Mar-02
Insight: Bolder moves are needed - Mar-02
Eurozone central banks weather financial storm - Mar-02

This has happened only three times in US history, and can be expected to happen only once or at most twice in a lifetime. Previous instances, according to Rob Arnott of Research Affiliates, were from 1929 to 1932 (when the fall in real terms was 83 per cent), from 1852 to 1857 (a fall of 66 per cent compared with inflation) and from 1905 to 1921 (a 65 per cent fall).

So another 15 per cent fall from Friday’s opening levels would make this the second worst overall decline ever, second only to the Great Crash of the 1930s.

This may not do that much damage to the notion that stocks are the best investments for the long term. In terms of a human lifespan, nine years is not that long.

But it gets worse. When compared with bonds, Arnott points out in a forthcoming piece for the Journal of Indexes that US stocks have now underperformed Treasury bonds since 1969. Very few savers actively putting money away today started much before 1969. Most of them did so during a period when the cult of the equity held sway. For this whole generation, that belief in equities has proved badly misplaced. Various long-term surveys show that there have been very long periods of underperformance by equities in the past.

But we can say that the current sell-off is almost without precedent for its speed. Arnott’s figures show that as Wall Street opened on Friday it was already dealing with the second biggest six-month decline in its history. The only bigger six-month drop was barely larger, at 51 per cent, at the end of the crash of 1932.

The good news is that 1932 marked the bottom of the great bear market of the 1930s, and that stocks rallied more than 100 per cent in a matter of weeks.

The bad news is that there were still 22 years to go before stocks regained their highs in nominal terms, and 26 years before they regained their highs in real terms, an event that did not happen until 1958.

I wish you people actually did some research before you wrote something.

Lastly, Cetin we know if you had the money to be following your investment philosophy for the past two years you are broke. The google you were telling everyone to buy at 750 went to 250. hope you are enjoying your losses. you really aren't able to tell the truth are you?

May 03 06:16 PM

[dcb:]

Although considering stocks have underperformed bonds since 1969, maybe now isn't that bad a time to start thinking about stocks again.


On May 03 06:16 PM dcb wrote:

> according to a recent article I read in the FT t-bonds would have
> outperformed stocks for about 40 years I believe.
>
> Long View: Why baby boomers will put their faith in bonds
>
> By John Authers
>
> Published: March 6 2009 20:23 | Last updated: March 10 2009 12:53
>
>
> These are bad days for the cult of the equity. The bare figures say
> it all.
>
> As of mid-morning on Friday in New York, after the latest terrible
> US jobs data, the S&P 500 index was down 64.4 per cent in real
> terms from a peak that it set in 2000.
> EDITOR’S CHOICE
> Analysis: Investment and the crisis - Mar-02
> Candover falls into private equity trap - Mar-02
> BIS seeks warning signals of crises - Mar-02
> Asean vies to find crisis response - Mar-02
> Insight: Bolder moves are needed - Mar-02
> Eurozone central banks weather financial storm - Mar-02
>
> This has happened only three times in US history, and can be expected
> to happen only once or at most twice in a lifetime. Previous instances,
> according to Rob Arnott of Research Affiliates, were from 1929 to
> 1932 (when the fall in real terms was 83 per cent), from 1852 to
> 1857 (a fall of 66 per cent compared with inflation) and from 1905
> to 1921 (a 65 per cent fall).
>
> So another 15 per cent fall from Friday’s opening levels would make
> this the second worst overall decline ever, second only to the Great
> Crash of the 1930s.
>
> This may not do that much damage to the notion that stocks are the
> best investments for the long term. In terms of a human lifespan,
> nine years is not that long.
>
> But it gets worse. When compared with bonds, Arnott points out in
> a forthcoming piece for the Journal of Indexes that US stocks have
> now underperformed Treasury bonds since 1969. Very few savers actively
> putting money away today started much before 1969. Most of them did
> so during a period when the cult of the equity held sway. For this
> whole generation, that belief in equities has proved badly misplaced.
> Various long-term surveys show that there have been very long periods
> of underperformance by equities in the past.
>
> But we can say that the current sell-off is almost without precedent
> for its speed. Arnott’s figures show that as Wall Street opened on
> Friday it was already dealing with the second biggest six-month decline
> in its history. The only bigger six-month drop was barely larger,
> at 51 per cent, at the end of the crash of 1932.
>
> The good news is that 1932 marked the bottom of the great bear market
> of the 1930s, and that stocks rallied more than 100 per cent in a
> matter of weeks.
>
> The bad news is that there were still 22 years to go before stocks
> regained their highs in nominal terms, and 26 years before they regained
> their highs in real terms, an event that did not happen until 1958.
>
>
> I wish you people actually did some research before you wrote something.
>
>
> Lastly, Cetin we know if you had the money to be following your investment
> philosophy for the past two years you are broke. The google you were
> telling everyone to buy at 750 went to 250. hope you are enjoying
> your losses. you really aren't able to tell the truth are you?

May 03 06:18 PM

[inthemoney:]

I wonder who is thumbing down the posts about CPI numbers being manipulated? My guess is that inflation just based on my experience was running at about 5% during 1999 - 2007, instead of reported 1-2%.
On the issue of baonds, don't bonds loose value during high inflation time? I don't consider them safe at all. The only relatively safe bet are real assets. Bonds only make sense if one is expecting deflation. But with all the money being created out of thin air, I don't see how we could possibly avoid inflation.

May 03 10:34 PM

[1.5 quadril...:]

Go to shadowstats.com and look at the free alternative inflation chart (click on alternative data link www.shadowstats.com/al...)

REAL inflation, even after this deflationary contraction, is still about
7%. The truth is out there!

But...it does you no good if all you do is take the fake data the crooks are pushin'.

This culture is a conspiracy aimed at the dunces who are even too foolish to form a confederacy...as in, "Confederacy of Dunces" - Great book by the way! The author killed himself cause he couldn't get it published but then his Mom (good 'ol mom's!) got it published for him posthumously.

You can still take the BLUE PILL while there’s time….





On May 03 10:34 PM inthemoney wrote:

> I wonder who is thumbing down the posts about CPI numbers being manipulated?
> My guess is that inflation just based on my experience was running
> at about 5% during 1999 - 2007, instead of reported 1-2%.
> On the issue of baonds, don't bonds loose value during high inflation
> time? I don't consider them safe at all. The only relatively safe
> bet are real assets. Bonds only make sense if one is expecting deflation.
> But with all the money being created out of thin air, I don't see
> how we could possibly avoid inflation.

May 04 02:25 AM

[dcb:]

maybe you think that kind of loss is acceptable, I don't.


On May 03 10:28 PM Cetin Hakimoglu wrote:

> Google is almost at 400. 700 isn't that far away.

May 04 03:51 PM