Recently, I decided to take a look at the inflation adjusted returns for the Dow industrials from 1928 to 2007. After doing the math, I thought: surely this can't be correct? By my numbers, once the Dow had been adjusted for inflation, it had increased at an annualized rate of roughly 1.5% a year over the last 79 years.
Now, this in itself wasn't too surprising, especially since dividends are excluded in that calculation. The historical annualized dividend rate for the Dow is reported to be roughly 2.5% a year, so a 4% annualized return each year after inflation isn't exactly terrible.
It was when I broke the Dow's return up into different timeframes that the big surprise came. If you exclude the last decade and a half, the inflation adjusted historical return for the Dow from 1928 to 1990 (62 years) was only 0.3% a year. At this rate, if dividends were excluded, it would take a person 210 years to double their invested money after inflation. Ouch!
Throwing inflation completely out of the window though for the moment, let's consider the actual return with inflation included for the Dow from 1928 to 1990 (62 years.) During this long time period, the Dow grew at rate of 3.6% a year annualized. Let's pretend that we're back in 1990 and the tech boom and crash never happened, and the Dow continued growing at its historical rate of 3.6% a year. Where would the Dow be today? The price of the Dow was at 2700 in Jan of 1990. At the 3.6% historical rate of return, that would put the Dow right at about 5000 today. This means that if the Dow was to revert back to its historical mean return, it would have to fall aroughly -60% from where it is now -- an almost 3x larger drop than the drop from the peak to the bottom of the 2000-2002 tech crash.
The Dow from 1990 to 2007 in comparison has grown at a rate of roughly 9.5% a year. Can this growth really be sustained? From GDP numbers i've looked at, the US economy post 1990 has not skyrocketed in the way that would explain such large increases in the US market. It appears to have slowed down if anything. Can anyone make a case to explain why the market has made such leaps in its annualized return over recent years, or is this merely a case of prolonged irrational exuberance that is bound to eventually end with a huge fall out in prices?
Now, this in itself wasn't too surprising, especially since dividends are excluded in that calculation. The historical annualized dividend rate for the Dow is reported to be roughly 2.5% a year, so a 4% annualized return each year after inflation isn't exactly terrible.
It was when I broke the Dow's return up into different timeframes that the big surprise came. If you exclude the last decade and a half, the inflation adjusted historical return for the Dow from 1928 to 1990 (62 years) was only 0.3% a year. At this rate, if dividends were excluded, it would take a person 210 years to double their invested money after inflation. Ouch!
Throwing inflation completely out of the window though for the moment, let's consider the actual return with inflation included for the Dow from 1928 to 1990 (62 years.) During this long time period, the Dow grew at rate of 3.6% a year annualized. Let's pretend that we're back in 1990 and the tech boom and crash never happened, and the Dow continued growing at its historical rate of 3.6% a year. Where would the Dow be today? The price of the Dow was at 2700 in Jan of 1990. At the 3.6% historical rate of return, that would put the Dow right at about 5000 today. This means that if the Dow was to revert back to its historical mean return, it would have to fall aroughly -60% from where it is now -- an almost 3x larger drop than the drop from the peak to the bottom of the 2000-2002 tech crash.
The Dow from 1990 to 2007 in comparison has grown at a rate of roughly 9.5% a year. Can this growth really be sustained? From GDP numbers i've looked at, the US economy post 1990 has not skyrocketed in the way that would explain such large increases in the US market. It appears to have slowed down if anything. Can anyone make a case to explain why the market has made such leaps in its annualized return over recent years, or is this merely a case of prolonged irrational exuberance that is bound to eventually end with a huge fall out in prices?
