I know I'm a bug about adjusting things for inflation, but I still wonder: Why is it that stock market charts are never adjusted for inflation? Here's the post-pandemic S&P 500 adjusted for inflation:
In nominal terms, the S&P 500 is up from 3800 to 4155 since the start of 2021. In real terms it's down from 4500 to 4155.
Keeping up with inflation ought to be the minimum baseline for looking at the stock market. Instead, it seems to be actively avoided. Even in text you never see analysts comparing gains to inflation. In times of low inflation this doesn't make too much difference, but it sure does over the past couple of years.
On short timeframes*, adjusting for inflation doesn't make a lot of sense. This is somewhere around the cusp of that. I'd say it's one where it doesn't quite make sense yet to adjust for inflation.
*Or "inflationframes" - a timeframe of inflation. It's not until inflation has totaled more than 10% or so that adjusting for inflation makes any sense. I don't have a rhyme or reason for that, just that until you reach +10% it's not much more than noise, and on time scales like that there is just going to be a lot of noise in the data as well as a lot of lagging indicators/measures.
Contrary to your desires, the world is NOT magically indexed to inflation.
CPI was 7.0% in 2021 and 6.5% in 2022 so there has easily been more than 10% inflation since the chart beginning time.
To adjust for inflation and not adjust for dividends would be ridiculous. Why do you do that all the time?
For a look at real-return performance that adjusts for both inflation and dividends, see the chart here:
https://totalrealreturns.com/s/VBMFX,VTI
The two Vanguard funds in the chart are total-market funds for stocks (blue) and bonds (red). You'll see the long-term real return on stocks went a little nuts while skyrocketing in 2020 and 2021. 2022 was a correction, and in 2023 stocks have returned to the long-term trend.
The long-term view is important.
Kevin's chart here can be deceiving because it begins at a time (Jan '21) when stock prices/returns were at an elevated level and due for a correction.
Rather than seeing the current market as moving in the wrong direction, the long-term view indicates that we are now on the long-term trend of the past couple of decades.
Yes, this too!
Since the chart at the link tracks returns from the end of May 2001, here are a few data points to consider.
Market Returns / Purchasing Power of $1
(S&P or closely-correlated VTI)
5/31/01 = $1.00
10/26/23
..Nominal: $5.33
..Adjusted for Inflation Only: $1.97
..Adjusted for Inflation + Dividends: $3.072 ("real return")
Different metrics serve different purposes. Nominal returns are useful for a variety of performance-tracking analyses. "Real returns" are useful for understanding how purchasing power of dollars is affected by investment returns and inflation. But adjustments for inflation alone are useful for virtually nothing. Don't ever do it unless you're intent on making a bad-faith case against the value of investing.
Another comparison of purchasing power of $1, adjusted for inflation.
Assume no investment:
5/31/01 = $1.00
10/26/23 = $0.58
I see what you're saying, but...ehhh. Financial assets aren't the same thing as goods and services.
I think showing "real return" (i.e. returns net of inflation) for financial assets makes total sense. But actual asset prices? I dunno. Feels like it's a little apples and oranges.
Of what ultimate use are financial assets other than to be convertible into goods and services?
Stores of value but that is nothing more than a non sequitor.
The people who have the most financial assets don't convert them into goods and services. They just use them to buy more assets. There's inflation in the asset market, but it is only weakly coupled to goods and services inflation, primarily in raising the cost of housing. People with lots of assets will spend a lot of money, but percentage-wise, the more they have the less goes to goods and services.
(So, yes, inflation adjustments for small scale shareholders might make sense, as for individual retirement planning, but for the people with the most invested it doesn't.)
Well, financial assets provide income (dividends, interest, etc), and the timing and amount of that income impacts their prices.
Returns from financial assets come both from that income and from capital appreciation (the change in the price itself). So simply showing the price of a financial asset isn't really a great way of measuring it's value over time.
My point was more about the direct price of a financial asset isn't the same as the price of a good or service one would consume. Inflation reflects the cost of consumption. Financial assets aren't like that.
But to your point, the *return* earned by a financial asset is absolutely intended to fund consumption at some later date. That's why I think the better way to adjust financial assets for inflation is by showing "real return" - i.e. nominal return minus inflation.
Additionally adjusting an inde is rather nonsensical (certainly simply as done by Drum)
what real world problem does this help us answer? what is the opacity that this suddenly makes clear?
Since we live in a nominal world, this chart likely makes the state of the market less clear.
The price of housing is way up, so the market is really down? Are you sure this is helping answer any questions?
Im hard pressed to come up with many (any?) assets where the current value is commonly indexed to the change in the cost of the CPI basket of goods.
Inflation adjustments are fine, but it's a bit like a nail gun..... indiscriminately blasting it at everything is a bad idea. You only need it when a nail will help, and even then you have to know how to use it.
Cmayo's point is a good one. Time periods need to be longer. Plus CPI-U is but one of many adjustment factors that are out there, and there's not always a good reason to think that one is more appropriate to your situation than others.
Let's say your 401K buys shares in a S&P 500 ETF every paycheck. You bought shares in VOO January at $350. Today it's at $380. About a 9% gain. You could adjust for CPI-U and that would have it go from $360 to $380, about a 6% gain. That may be informative. But if you're not selling for another 20 years, it doesn't tell you much, particularly if inflation is going to be in a "normal" range during that time. The long term goal is to invest with gains that exceed inflation. Most people during normal inflationary times just want to look at their statement and see year-over-year gains at 3%.
Also, the point above about dividends is really really important. Financial analysts when comparing two equities over time will look at both the price return and NAV return.
A lot of my point was also that you were buying shares at $350 in January and given that wages lag behind inflation, and indeed are not indexed to inflation, you're likely still buying at $350 today and not $380.
I have to agree with Joseph Harbin; the best measure of market performance is total return. jdubs -- the real-world question is where would I have done better in the last year/two years/five years? Stocks? Bonds? CDs? Precious metals? Collectibles? For comparison purposes, either none or all should be inflation-adjusted. Of course, that doesn't shed much light on the more interesting question, which is where will my money do better in the next year/two years/five years?
But now you are talking about returns, not asset values. This chart doesnt show you returns.
The inflation adjustment would be applied equally to all assets. Comparing nominal returns to real returns would give you the same answer when comparing different investments. So while that is an important question, this type of adjustment isnt useful for that purpose.
It might be because inflation - actual & anticipated - is "priced in" to the stock & bond prices. I don't know if it's true, but that's what people who claim to know say.
One of my favorite stock market things is when financial wizards say and event - like the Fed doing a .25 raise - is "priced in" then the event happens and the stock market goes crazy. Same with increases in GDP growth, changes in CPI, etc.
Why not pair this with a chart showing the inflation-adjusted investment performance of cash stored under the mattress? That's the realistic alternative to investing your savings in financial assets.
Kevin, why do you hate Bidenomics? …
Remember, the market is not the economy. Profits are up, unemployment is way down, wages are staying a bit ahead of inflation -- oh, woe!
I think part of it is simple habit, or path dependency. Once upon a time, equity indices weren't talked about commonly, and so didn't get focused on as much by lay people. There was no CNBC. The most you'd get from the evening news was a single line about how the stock market had done that day (normally quoting the Dow, not the SP500). Presumably, financial professionals had a sense as to what the recent rate of inflation was, and could do the the necessary mental arithmetic—they didn't need this detail from journalists. Reporters thus never got in the habit of citing inflation-adjusted numbers.
Kevin is making his normal mistake in trying to adjust for inflation.
Adjusting for inflation is often helpful but adjusting for other factors is often helpful too.
In this case, it is absurd not to adjust for dividends.