I asked my listserv buddies at NICAR if I was smoking the wrong stuff: just why do we get excited about record highs in the stock market and forget to account for inflation?
A couple of weeks ago the folks at Planet Money aired a story arguing against the record highs because none of them account for inflation. Two weeks ago we were all talking about the Dow Jones Industrial Average.
On Thursday we were talking about the S&P 500.
The New York Times reported that the S&P 500 finished Thursday at $1,569.19, breaking it’s 2007 record. And it did break its previous record, but not when accounting for inflation.
If figuring for inflation, the record “actual” high for the S&P 500 was on March 24, 2000 with a closing price of $2,079.22. So, we’ve got a long way to go, right?
I spent the better part of Thursday visualizing this data and making sense of it all. I sourced my data from Yahoo! Finance and the Federal Reserve Economic Data site. If you want to see my Excel spreadsheet, it’s here.
The two lines (closing prices and those adjusted for inflation) get closer together on the right end of the graph because those dollars are closer in worth to today’s (February’s) dollars.
Inflation is a continuous rise in the average price level and is measured by comparing the change in the consumer price index from one year to the next. The index is calculated monthly by the Bureau of Labor Statistics and is a measurement of the average change in prices paid by urban consumers for a market basket of goods and services.
The conversation on the listserv helped me, but also left me a bit confused.
1. I am smoking the right stuff!
Including inflation-adjusted prices for a stock index (let’s just focus on the S&P 500) is a good idea, but including the dividend yield is also good idea too.
2. This type of inflation doesn’t apply to market indexes
The rise in a stock price is, in itself, inflation. The higher prices are a result of increased demand in the stocks in that index. And so the price goes up. The S&P 500 includes market capitalization, which looks at the number of shares issued by a company.
3. But what are dollars anyway?
Typically consumers don’t buy stocks with gold or Pop-Tarts, they use dollars. So, if we talk about buying stocks in 2000, 2007 or today we have to do it with the one unit of account most people agree on. And that’s the dollar. And the power of the dollar changes over time.
4. What are we celebrating?
Another interesting takeaway from Planet Money’s episode is that when the average person celebrates a record high in the market they’re actually celebrating the rich getting richer. As Adam Davidson points out, typically the wealthiest Americans own stocks. And this could lead to more income inequality. Or more jobs. Or layoffs. Or a number of unpredictable things. But the rich do get richer. What they do with that money is up to them.
So, we’re left between a rock and a hard place. The financial philosophical debate will rage on after every record high until we end up realizing that stocks might not be the best metric of the health of the U.S. economy over time. But the record highs of stocks might be good news on an otherwise slow day.