Food for Thought: Market Levels in Inflation Adjusted Terms

Consider the inflation adjusted values in the three major US markets.  If all economic value (real return in excess of inflation) created in the last 8 and 18 years respectively were to be completed wiped away, such that there was no economic growth, but just an accounting for inflation, the indexes would settle as follows from their 2007 highs.

Inflation Adjusted Market Values 2007 Dollars

Inflation Adjusted Index Values in 2007 Dollars

The way to read this table is that the 2007 DJIA high of 14,093 would be equal to 11,704 in the year 2000, using 2007 dollars.  Similarly, the DJIA high in 2007 is equal to 8,883 in the year 1990, adjusted by 2007 dollars.  Of course this is less than scientific because the constituents and weightings of each of these indices has changed dramatically over the periods observed.  Nonetheless, it is an approximation.

Assuming approximate accuracy in this method, simple logic would indicate that the above referenced table illustrates negative real returns in all three indices since 1990 given recent index prices.  If that is to be true, then we would need to see a much more serious and severe contraction in GDP to make today’s index values indicative of fundamentals.

Now consider the table below.  This table represents actual index values at the end of the years 2000 and 1990.  These historical index values have also been adjusted for inflation in 2008 dollars for a comparison the other way around.

2000 & 1990 Closing Inflation Adjusted Index Values

Year End 2000 & 1990 Inflation Adjusted Index Values

The way to read this table is to look at the end of year index value for 2000, or for 1990 and consider the inflation adjusted value to the right.  For example, the S&P 500 closed the year 2000 near 1,320.  The inflation adjusted value for the S&P 500 from the year 2000, in 2008 dollars, would be 1,660.  Thus with no real growth in the S&P 500, inflation alone would have brought the S&P 500 up approximately 25%.  Similarly, the inflation adjusted year-end value of 328 for the S&P 500 in 1990 would be 544 in 2008 dollars.

From some sides the market seems quite overblown, but from others it could have a long way to go.  I suppose the two questions here would be: 1. How much real economic value had been destroyed? 2. What do the cyclical growth prospects look like for the economy over the next 10 to 20 years?

Whatever the answers are we will only know in hindsight.  However for the current market to be accurately reflecting reality, reality will have to get a whole lot worse.

Inflation Calculator


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