In the 100-year Dow Chart post yesterday, the following issue was raised in comments:
It would be nice to see your "100 Year Chart , DJIA" deflated by
some ”inflation” indicator (either consumer price index or wholesale
price index or earnings index or commodities index or real estate
index), or at least in a logarithmic scale.Indeed it might be even better to see it overlaid with all those indices, to give a sense of perspective as to available macro trend investment choices…
Thormika Keo took up the challenge: he went to Yale Professor Robert Shiller’s website, downloaded Shiller’s data for the Real S&P500, and overlaid it with our periods for for each bull and bear market.
This is what it looks like:
Inflation Adjusted SPX, 100 years, with Bull Bear Cycles
Adjusting for inflation puts the Bull and Bear periods into even sharper relief. It also shows how totally bubblicious the late 1990s were, and why many strategists and technicians started pulling in their horns in the mid-1990s.
If you want to see this chart in its full 1020 X 554 glory, you can download it here: modifiedshiller.jpg
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There is also a CPI adjusted Dogs of the Dow, here.
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With this post, we add the sub-topic "Valuation" to our list.
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UPDATE JUNE 11, 2006 1:54PM
I am out on a sunny Sunday, doing some gardening, washing the car, when I come into to see a cry coming from the crowd: We want Log charts! We want Log charts!
And logarythmic charts ye shall have:
Inflation Adjusted SPX, 100 years, with Bull Bear Cycles (LOG)
A wide-ranging chart such as this must be displayed with logarithmic vertical axes, instead of linear, to prevent the lower values from vanishing into apparent insignificance. With logarithmic vertical axes, a vertical displacement of an inch, for example, would represent a constant percentage change over the entire chart, which is what you should really want.
Regards, Don
I don’t know, if your intention was to provide us a “cheap” visual misleading of how overvalued the market is, though it seems to me at least worth to mention, that the readers should take a more precise view on the data provided by the same source:
E.g. the P/E ratio is (since available) not that dramaticaly risen as the chart may suggest – hence the earnings scale is “artificially” build that way to make it look as if there were a giant gap between earnings an prices. Alone a linear scale for periods of more than 100 years (for something like earnings ans stock prices where compound interest is a central “driving force”) is highly misleading.
Maybe I’m just thick, but please help me out on something here:
The S&P 500 on this chart is the “actual” index right? And that index is made up of “nominal” stock prices, right? So how can you adjust the earnings for inflation, without adjusting the stock prices (i.e., the index) for inflation? Or am I thick and missing something here?
It seems to me that ecomonic data should somehow be normalized to population growth, if the population grows exponentially, so should the S&P if production is related to population output. So, maybe per capita growth and earnings would be more useful. I agree with the use of a log scale since percentage can then be directly inferred.
This is starting to sound ungrateful for your efforts, sorry.
Excellent chart. Thanks to you and Thormika for the extra effort. Like some other readers it’d be nice to see against a log scale to help normalize it in persective. Which would also implicitly adjust for underlying growth in pop or the economy as well. But after all you can’t do everything.
An interesting exercise is, in whatever form you take this chart, to walk thru the bear periods and map them to events and longer-running economic trends. That is things like the post WW2 shift to truck-based transportation, pharmaceuticals, electronics and computers, etc. which were the components of that wave of industry invention and innovation.
I would subtmit that the NBT (Next Big Thing) causes the production possibilities to shift out not only in the industry and associated ones but in the economy as a whole. And that we’re seeing a fallow period where not only financial excesses must be worked out but there are no more shifts waiting in the wings until we’re a ways out (think new systems biology). In the meantime the markets have actually been flat since ’98 as has GDP relatively speaking and earnings growth was a recovery from a trough. Not new growth. If/as we revert to the mean of 6% l.t. earnings growth and PE’s retreat to more normal (mean) numbers…well it looks like we might have a lot of fun indeed.
Since inflation has been systemically understated for the past 11 years (Boskin Commission) the chart underestimates the pullback in the SP the past decade.
That’s a very telling chart. Rather than looking at what appears a parabolic run that really isn’t comparative to the other cycles, the true value of the chart does tell some of the underlying dynamics of cycles.
Btw, not to nit pick as Don stated, but if semi-log paper was used to plot this, the run from 1980ish wouldn’t be so distorted. The cycle leading up to the late 60s was also a low inflation period and without adjusting for such, the nonadjusted return for that period was actually higher than the 1980-2000 run yet on this chart is appears insignificant because of the straight line plot.
Ditto on the log scale. So here it is.
Context is everything. Here’s a log-scale picture with P/E that tells the other story.
I’m very interested in how 401k investing changed all these dynamics. There’s not enough discussion about how much money has come into the market as a result, and its effect on price and P/E.
The much scarier second part of that discussion is, of course, what happens when that 401k money starts coming out of the market?
Mark Spiegel: It is adjusted “backwards”, i.e. in “today’s dollars”. That is, recent values are about what they actually were, and past values are inflated. You can double-check that by comparing to a linear chart on your favorite finance website.
Wow, thats nice, thanks to you and Thormika Keo. I had started looking at the St. Louis FRB site which has lots of stats going a fair bit back to overlay, but had not found yet some of the series I would like to see.
BTW, before people get very excited about next big things and the 2000 bubble, that site has these two entertaining long term graphs on a couple of relevant interest rates:
http://research.stlouisfed.org/fred2/series/MORTG/114
http://research.stlouisfed.org/fred2/series/TB3MS/116
I particularly love the ”Greenspan effect” on the 30y mortgage rates… :-)
«It seems to me that ecomonic data should somehow be normalized to population growth, if the population grows exponentially, so should the S&P if production is related to population output.»
I would compare more to GDP than population.
But why a company should be more valuable if it has a bigger turnover even if earnings do not go up in the same measure? So the first idea should be earnings.
«I’m very interested in how 401k investing changed all these dynamics. There’s not enough discussion about how much money has come into the market as a result, and its effect on price and P/E.»
It is not just 401k investing, it is in general accumulation of pension funds. But yes, whenever you talk stocks one should never just talk price and PE, but also volume and net inflows or outflows. That would also be nice…
«The much scarier second part of that discussion is, of course, what happens when that 401k money starts coming out of the market?»
Thats one of my favourite (or not) topics :-). The problem here is that pension funds are managed according to actuarial strategies, in a totally formulaic way, and the typical strategy is accumulate stocks until the beneficiaries are 60 and then convert those holdings into bonds as retirement nears. It just happens the baby boom (1946-64):
http://en.wikipedia.org/wiki/Post-WW2_baby_boom
«By the end of the decade, about 32 million babies had been born, compared with 24 millions in the lean 30s. In 1954, annual births first topped four million and did not drop below that figure until 1965, when four out of ten Americans were under the age of twenty»
and that the baby boomers in 1995, when the great bubble started, were in the 50-30 range, with an average of 40, which is when people start putting serious money in their accounts.
My favourite example of the madness of the surge, which has made Warren Buffett especially rich, is that the biggest winners have been the usual blue chips that formulaic investment strategies put into pension funds.
For example, I fancy myself to have some knowledge of IT and its companies, and I am totally amazed by IBM’s price over the past few decades:
http://finance.yahoo.com/q/bc?t=my&s=IBM&l=off&z=l&q=l&c=
In the 80s IBM was a monopoly with a license to print money, and now that after going bust it has become mostly a me-too body-shop it has a much, much bigger valuation and P/E? What gives? Well, look at the volume histogram below…
Uncle Bob —
Normalizing for pop growth? Please explain the benefits of what that would show?
And by all means, mash one up together and I’ll take a look at running it.
Barry,
I watched your TV interview last night and had a couple of questions. If you have a chance, please respond:
1. I thought Japan was benefiting from China as much as Taiwan and Malaysia are. Why are you sour on Japan while positive on the rest? My understanding is the pacific economies are slowly coming together to become self sufficient instead of having to depend on US for their growth. Obviously it takes time, but as that happens, Japan plays a significant role in that zone.
2. You had some scary projections for the major indices. If the market gets anywhere close to those numbers, clearly it would be on the back of a deep recession in the US. In that case, what makes you think that energy and metals/materials will continue to do better? Won’t demand for resources go down in a deep recession? Won’t P/Es compress for all companies, even if they are dealing in materials and energy, unless, of course, prices of resources inflate. So is it reasonable to expect that you think commodities and energy will continue to inflate in price even if the economy cools down dramatically?
«An interesting exercise is, in whatever form you take this chart, to walk thru the bear periods and map them to events and longer-running economic trends.»
Well, it would be interesting to compare to other asset classes like gold, median house price, timberland, UK or european stocks, and other indicators like median wage, or as suggested before GDP or even population.
Just to get an idea of trends, trends are quite important. A somewhat less than smoothly written, but pretty decent investment advice book by a trader, “Taming the lion”:
http://WWW.Harriman-House.com/pages/book.htm?BookCode=21815
makes the good point (with graphs and numbers) that macro long investing is about 1) moving among different asset classes 2) identifying and riding macro long trends.
Oh well, I’ll try to do my bit if I can find the data.
«deep recession in the US. In that case, what makes you think that energy and metals/materials will continue to do better?»
«in the US» indeed, but there are two giant countries and several smaller ones that will continue growing. A lot of their growth depends on exports to the US, but even so…
Thanks Barry. Now that we have the real, logged S&P can we suggest some interpretations ? Just plowed back thru ‘Cult of the Bear’ series and take-away the notion of a down drift to Dow 8800 scaring folks and then an external event driving it to your 6800 figure ? In looking at the graph, this cycle and previous ones it doesn’t look as if we’ve given up anything so far this time around. In other words that last little bubble from ’98-’00 is still the floor. In prior bear periods it seems that at least 1/3 of the ceiling was eroded over the following bear periods, e.g. in the ’66-’82 bear ? So this time around, given the kitchen-sink steroided stimulas economy, where do we end up when we go cold-turkey ?
«I thought Japan was benefiting from China as much as Taiwan and Malaysia are. Why are you sour on Japan while positive on the rest?»
One can have mixed feelings about Japan; yes, it is exporting a lot to the USA via Chinese assembly factories (was doing the same masquerading its important via Korea for a while), and it is getting out of its depression, and still has world class companies.
But it is still a country with an insider/outsider market structure, where the insider sectors are still appallingly inefficient (and large), and with a rapidly ageing and shrinking population, and eventually world class chinese companies will emulate and overtake Japanese ones (consider the Korean example with famously Samsung).
Betting against Japan is always dangerous in the long run, but it does not look like a growth story to me, at least not on the scale of the newer developing countries.
«I’m very interested in how 401k investing changed all these dynamics. There’s not enough discussion about how much money has come into the market as a result, and its effect on price and P/E.»
I forgot to mention these two references, one an article on precisely this issue:
http://mahalanobis.twoday.net/stories/321345/
and this graph, which may be unrelated (probably is), but is astonishing nonetheless, because of the divergent trends, but also because of when they peaked and when they started to diverge, extremely odd stuff:
http://www.economist.com/images/ga/2005w11/Bond.gif
Looks like the treasuries peaked at one point in 1995, and foreigners started buying them like crazy in 2001-2002, and USA investor are continuing to shun them.
Blissex, thanks for the thoughts. The three macro positives that make Japan interesting to me have been:
1. Economic recovery after a prolonged slump
2. Proximity to the fast growing economies of the world
3. Rising interest from domestic investors in the Japanese stock market. They have shunned it for several years after the 1990 Nikkei crash.
I understand it is not that simple, so will continue to monitor Nikkei. The recent BOJ moves with the Japanese monetary base have been dramatic. Don’t know what that means for Nikkei. The brain hurts thinking about these dependencies .
Here’s an idea for you Barry,
How about a stock picking contest? Let’s see how savvy your board experts really are. Give everyone one pick over a year’s time. I think mutual funds and indexes could be included as well. You may also want to bring in a monthly, quarterly and half year contest to keep people’s interest who come in late. Maybe get some of your favorite investing books as prizes or subscriptions to your new site. Not only will this keep people coming back to the site but we can get ideas from each other and you could put together a board porfolio to see how well we really do. If we keep it to one pick each then we will really be gleaning the best of the best and forcing the very top picks from everybody.
I’ll bet some great ideas come out of the minds of this board. Imagine the synergy
PS,
I’m thinking leaps and shorts could be put into the mix as well.
«The recent BOJ moves with the Japanese monetary base have been dramatic. Don’t know what that means for Nikkei. The brain hurts thinking about these dependencies.»
Oh yes, that is my sentiment (and I am not a trader, just a keenly interested observer) and Japan is a mystery. It is precisely because it is so opaque that it seems to me dangerous to trust that the many positive fundamentals may influence the stockmarket.
For example, I guess you have noticed that the central feature of Koizumi’s manifesto was the privatisation of the Post Office.
This actually is a very significant issue, of enormous financial and political importance, but for somewhat indirect reasons and the very fact that such a seemingly peripheral issue is actually so important that show how difficult is to make rational assessment of Japan’s situation.
I suspect that those that go in look hard and have some local knowledge and pick and choose advisedly the precise opportunity can make a killing, which suggests that this applies mostly to private equity investors.
What I don’t think there is yet is a tide that lifts all boats, like the «ultra loose» monetary policy in the past few years in the USA, or the super-growth in China, so assessing Japan as a whole is a bit difficult from my point of view.
True. I guess you could say the same of many foreign markets. If Japan is a mystery, imagine the emerging markets! It is my general impression that companies operating in countries with a shorter stock market history and a market with less participation are generally more opaque and are run more to serve the interests of the insiders than that of the common shareholder. I was shocked to see people rushing into emerging markets with such gusto the past few years. FWIW, Japan position is small (via EWJ) and I’ll reevaluate it in light of what is happening in the US.
All this talk about a logarithmic chart… baloney!
From what I see, it is pretty clear that everything was fine until 1995. Things only started to get out of whack in 1995 and you don’t need a logartithmic chart to make this deduction.
When you have to look at dozens of charts to prove your point, it’s called denial.
Could you correct for survivor bias in the S&P500 on these charts? While the index can happily remove a bankrupt company and replace it with another at some nominal value, this isn’t possible if you actually hold the stock.
More realistically, could you provide an estimate of the trading costs that would be incurred in adjusting the index portfolio?