Below is an excerpt from this document which compares investments in gold, bonds, stocks and housing in France over the 1800-2005 period. This excerpt says the 1800-2005 period shows a rather regular yearly increase of “6.6% + inflation” in the price of US stocks.
(by inflation the author means price index, and by US stocks the author means the S&P 500 and some other indexes before the S&P 500 was created)
Can someone explain to me in simple terms why the US stock market keeps going up in the long run? Is it just state violence? Is it just credit expansion? Or are there solid free market reasons as well?
Were you expecting to see something different? Most of the companies that make up the stock market indices provide valuable goods and services. I would expect them to be productive, grow, and reward investors with a healthy rate of return.
Inflation is a pretty good reason why stocks keep rising. It is just as misleading as GDP’s rate of increase.
That’s not to say a company or some companies can’t have steady positive growth rates over larger periods of time. But if we look at the current economical situations, it seems that even large and composite indices keep growing.
But let’s not forget you can’t redeem stocks in goods owned by the company.
Some things to look at are the average P/E and average P/B of the stock market. They tell something about the economic situation.
I’d be curious to look at the underlying data, because there’s several important factors:
The data to be measured between 1800 and 1913 in the US was under the gold standard, and had steady price decrease through out the 19th century, while the 20th century had a fiat money with massive inflation. How can that graph get a deflator that arrives exactly at a straight line, makes it look very suspicious.
Stock indexes in the 19th century are not comparable to today, unless I’m mistaken, the Dow had 4 companies in the index for the last decades of the 19th century. I have no idea which company stock can be used for the early 1800’s.
Capital market changed so much from the beginning of the industrial resolution in the US, which was an agricultural based economy, to now, that would make stock return fluctuate significantly.
It took until 1954 for the US stock market to reach the level (in nominal term) that it had in 1929. In constant $, it would be even later. Where’s that reflected in the chart?
Bottom line: I’m highly suspicious of the data and method used to chart that straight progressing line.
To illustrate my point, look at the Dow Jones index history from 1900:
By factoring this chart using constant $ instead of nominal figures, it would make the 1929 boom even bigger and the subsequent years much more modest.
For instance, the US stock market was in a long bear market from 1970 to 1980 (and declined in constant $), where is that shown in the original chart? I call baloney.
Consumer price index: - Before 1913: Historical Statistics of the United States (Bicentennial Edition, 1975). - From 1913: US Bureau of Labor.
Value of an investment in US stocks, dividends reinvested: - 1802-1871: after (Schwert, 1990). - 1871-1999: after (Shiller, 2000). - 1999-2005: S&P500 total return.
So for the 1802-1999 period the chart is based on two previous papers. I don’t know the data sources used on these papers.
Some possible reasons why this chart is different to the Dow Jones:
This chart includes reinvested dividends.
The Dow Jones only includes the largest companies, and it has a specific calculation method. This chart is supposedly based on broader indexes (eg S&P 500) covering a larger part of the US stock market.
I missed that, but it doesn’t really affect the analysis. That’s because, especially in the case of stocks, inflation creates bad judgment in investors’ minds. Seeing higher-than-expected returns, they keep buying stocks at growing prices. Even if you account for inflation (which is calculated with a market basket price index), you can’t precisely account for its effects.
“…why the US stock market keeps going up in the long run?”
Jeremy Siegel has pointed out in his work Stock for the long run that during one year holding periods, stocks beat bonds only about 61 percent of the time. During 30-year holding periods stocks beat bonds amazing 99.4 percent of the time.
With praxeology, you can argue that the good performance of stocks is simply extra risk premium. A stock can lose all of its value rather quickly. An investor wants, on average scenario, more return for his money than what he could get by buying bonds, especially because the potential extra dollars he can get has less subjective value for him due to the law of diminishing marginal returns.
