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DOW adjusted for inflation?!

SSSnail

Lifer
Nov 29, 2006
17,461
80
86
I came across this website that supposedly calculated the DOW adjusted for inflation, calculated to 2000. I don't know much about it, thinking that there are many economic experts here can help me understand the site a bit better.

Quit a bit of read and has a lot of numbers, some graphs. See for yourself.
 

blackangst1

Lifer
Feb 23, 2005
20,892
828
126
His correlation between DOW and dollars is laughable. Pretty mindboggling page.

The DOW is only 30 companies first of all, and is a scaled average and price weighted.

edit: from wiki: Today, the average consists of 30 of the largest and most widely held public companies in the United States. The "industrial" portion of the name is largely historical?many of the 30 modern components have little to do with heavy industry. The average is price-weighted. To compensate for the effects of stock splits and other adjustments, it is currently a scaled average, not the actual average of the prices of its component stocks?the sum of the component prices is divided by a divisor, which changes whenever one of the component stocks has a stock split or stock dividend, to generate the value of the index. Since the divisor is currently less than one, the value of the index is higher than the sum of the component prices.

 

blackangst1

Lifer
Feb 23, 2005
20,892
828
126
For some reason I couldnt edit my edited post...but I wanted to add although I see WHAT he is doing with this, Im not sure why, or what significance it has on anything. Interesting I guess.
 

LegendKiller

Lifer
Mar 5, 2001
18,256
68
86
I will have to think about this further to debate the rationality behind this approach. However, I do have some initial thoughts.

1. The results do not surprise me all that much. We know that stock valuation includes a portion of inflation and a portion of risk, in the valuation of returns. As such, stocks should return rates higher than inflation to compensate for the short-term volatility of equities.

2. In periods of high inflation the value of companies can be eroded due to "real" decreases in prices if prices do not match the rate of inflation. Considering the periods of higher inflation, or stagnation of the market without appreciation at inflation, would result in an erosion of value.

3. The overall annual return of 1.64% seems low to me, mainly because most studies show annual rates of return around 10%. One likely cause would be the exclusion of dividends in the equation of returns, which remove value from the index while providing return outside the auspices of the index itself. Another factor could be the mechanics of the index itself.

The study wasn't tying the index value to the dollar, it was removing the rate of inflation from the equation. However, periods of reduced appreciation could be prolonged lulls in the appreciation, or the returning of rationality. The recent "boom" outside of inflation could either be a removal of rationality, resulting in a big asset bubble, or the real long-term rate of appreciation for this economy.

Given that P/E ratios are not exactly irrational, I would hazard to guess that the appreciation seen in the recent years isn't too far outside of the "norm" and that the long-term rate of appreciation is above the 1.64% presented.

Of course, additional noise can be included with the adjustments made to CPI, such as technology improvement divisors and such. Additional noise can be seen in the different make-ups of the economy, which is why it would be interesting to repeat this for the S&P500 or other indexes, as well as international indexes.

I will ponder more and also await the feedback of other members who might have some great thoughts of this. although I do expect from RPBs to pop in here and add some tripe.
 

StageLeft

No Lifer
Sep 29, 2000
70,150
2
0
It's kind of always adjusted for inflation (I mean, investors know to adjust it). If the market turns out 10% historically, as it has (give or take a bit), one always know that the true appreciation is closer to 6-7% because of inflation's attrition.
 

rchiu

Diamond Member
Jun 8, 2002
3,846
0
0
couple of thoughts. First, this graph highlights the risk of investing in stock with returns after inflation adjustment. Risk in stock is defined as variation, and you see here more big drops and jumps. In the Dow graph without inflation adjustment, you see more steady increase without much big drops and jumps. And you also see a longer period of negative return after adjusting for inflation, for example from late 60 to early 80s.

Second, with this graph, dow seems to reflect the economic condition at the time better. For example, the drop between late 60's and early 80's represents the economy at that time.
 

blackangst1

Lifer
Feb 23, 2005
20,892
828
126
Originally posted by: Skoorb
It's kind of always adjusted for inflation (I mean, investors know to adjust it). If the market turns out 10% historically, as it has (give or take a bit), one always know that the true appreciation is closer to 6-7% because of inflation's attrition.
Yep. Thats close to what scaled averaging and price weighting do.
 

Fern

Elite Member
Super Moderator
Sep 30, 2003
26,907
173
106
I don't see the any point to this graph as it doesn't take into dividends. For the longest dividends were extremely important to investors as they were mostly retirement plans and need the cash to fund pension payments.

Even companies with a loss for multiple years held their dividend steady.

IMO, it does a damn good job of showing how unfair cap gains tax unless you index it for inflation (as other countries do). Under the US method (no indexing, just lower rate) many people paid a lot of income tax on non-existant gains.

I suppose Congress knows this and that's why we don't index.

Fern
 

glenn1

Lifer
Sep 6, 2000
25,383
1,013
126
Originally posted by: SSSnail
I came across this website that supposedly calculated the DOW adjusted for inflation, calculated to 2000. I don't know much about it, thinking that there are many economic experts here can help me understand the site a bit better.

Quit a bit of read and has a lot of numbers, some graphs. See for yourself.
The author (probably intentionally) uses an arithmatic graph rather than semi-logirythmic - using the "mountain chart" severely distorts the long term trends.

Also, the author presumes (incorrectly) that past performance is predictive of future results. One of his sources (link) all but predicts that a futher ~60% retracement needs to occur (from today's levels, not the Oct peak) to bring the index back to the author's predicted "1.8/three warnings line."

 

Rainsford

Lifer
Apr 25, 2001
17,515
0
0
Originally posted by: Fern
I don't see the any point to this graph as it doesn't take into dividends. For the longest dividends were extremely important to investors as they were mostly retirement plans and need the cash to fund pension payments.

Even companies with a loss for multiple years held their dividend steady.

IMO, it does a damn good job of showing how unfair cap gains tax unless you index it for inflation (as other countries do). Under the US method (no indexing, just lower rate) many people paid a lot of income tax on non-existant gains.

I suppose Congress knows this and that's why we don't index.

Fern
Well also because it's hard to care too much about the horrible plight of people who make a significant portion of their income from capital gains. I mean, yes, in a perfect world it would be more "fair", but when we're talking about lowering the tax burden, generally people heavily invested in the stock market take a back seat to folks working three jobs to try to pay the mortgage. Which is, you know, not a totally unreasonable position...and I say this as someone who would definitely enjoy lower cap gains taxes.
 

charrison

Lifer
Oct 13, 1999
17,033
1
81
Originally posted by: Rainsford
Originally posted by: Fern
I don't see the any point to this graph as it doesn't take into dividends. For the longest dividends were extremely important to investors as they were mostly retirement plans and need the cash to fund pension payments.

Even companies with a loss for multiple years held their dividend steady.

IMO, it does a damn good job of showing how unfair cap gains tax unless you index it for inflation (as other countries do). Under the US method (no indexing, just lower rate) many people paid a lot of income tax on non-existant gains.

I suppose Congress knows this and that's why we don't index.

Fern
Well also because it's hard to care too much about the horrible plight of people who make a significant portion of their income from capital gains. I mean, yes, in a perfect world it would be more "fair", but when we're talking about lowering the tax burden, generally people heavily invested in the stock market take a back seat to folks working three jobs to try to pay the mortgage. Which is, you know, not a totally unreasonable position...and I say this as someone who would definitely enjoy lower cap gains taxes.
Since you take this position, then i assume you would rather extract more from the rich by a lower cap gain tax than a higher cap gain tax which yields less revenue. Cap gains at 15% has done a a much better job of getting revenue than when it was at 25%.
 

shira

Diamond Member
Jan 12, 2005
9,567
5
81
The author lost me when he wrote:

It is really amazing how unindicative of the future both of these first two peak values were. The average of the Real Dow values from 10/29 to any later time took 77.8 yr to reach the 31.6 value of the 9/29 peak! At 1/08, 78.3 yr post-peak, the average is 32.0 = 101.5% of 31.6. And the average of the Real Dow values from 2/66 to any later time has never reached the 46.4 value of the 1/66 peak! At 1/08, 42.0 yr post-peak, the average is 43.1 = 92.8% of 46.4.
But the 1/08 value in the "Real Dow" chart is about 89, not 32.0. And clearly ALL of the chart's post-1996 Real Dow values exceed the 1966 peak value, with the highest peak at 100, in 2000.
 

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