03/2024 - Inflation Adjusted Returns
Full written article below.
A lot has been written about the meteoric rise in stock prices from October 27, 2023 through February 29, 2024. I think everyone can understand why, in these short few months, the S&P 500 has rocketed higher by over 23%.
Source: www.kwanit.com
And I guess I can’t blame people when they think, “well, the market has shot up higher so it must only go down from here, right?”
Well, I’ll never try and say whether the market will go higher or lower in any short period of time, but I do think it’s helpful to zoom out. Prior to January 2024, it was just over two years since we had a NEW all-time high in the S&P 500.
The last all time high was on January 3, 2022. From Jan 3, 2022 to February 29, 2024, the annualized return has only been 4.68%. Clearly not stellar returns, BUT, you all know the adage, it’s not what you make, it’s what you keep. So it’s important to not just look at the S&P 500 gain, but the gain compared to inflation to create the inflation adjusted real return. That tells a very different story in that the date compared above, inflation is actually exceeding the S&P 500 return!
Source: www.kwanti.com
Would you agree this is incredibly important? But tell me, have you ever seen this very simple chart before?
From my perspective as a financial advisor, I’m continually surprised how consistent long-term returns are in the broad market.
In the below chart from Yardeni Research, you’ll see the S&P 500 from 1935 had an average return of close to 10.7%, inflation over this same period of time was 3.6% so the effective real return was close to 6.9%.
Then similarly, and looking at a separate data source, research from Wharton’s Jeremy Siegel who continues to publish and update his classic investment book, Stocks for the Long Run, the information from 1802 show a shockingly consistent real return of 6.9%.
And at risk of piling it on, in 1973-74 when the US had high inflation, an oil embargo that quadrupled the price of oil along with the Watergate scandal from 1973-Feb 29, 2024, the real inflation adjusted return in the S&P 500 is still 6.8%, source.
But again, from my financial advisor perspective, there’s a fundamental problem with all of these long-term data sets that continue to show the effectiveness and efficiency in the broader market. All this information is what’s happened in the past, not what’s going to happen in the future.
And if you’re like me, knowing my history is great and all, but I really want to know what’s ahead of me, what does my future look like?
When designing multi-decade financial plans, these are all projections into the future which is fully un-knowable.
This is precisely why when designing financial plans, I purposely utilize low growth rate assumptions. Sure, I can show you countless charts about the broad market growth over the past 10, 20, 30, 70, etc… years, but we have no idea what the next 20-50 years will look like.
What’s more, when I do a search for online “Retirement Calculators” I find numerous online calculators, many of which are using terrible assumptions, at least in my opinion. Probably the worst offender is a site that encourages people to input their assumed rate of return, and on the page they state the historical number of 10-12%, but this site makes no adjustments for inflation drag. I find this calculator to be dangerous and mis-leading.
Not only understanding these variable inputs but also how to manage these inputs is why developing long-term financial plans is a time-intensive and evolving process for each client. Every time I meet with a client and we update their financial plan, the assumptions have changed, investment results have changed, and the inputs have changed. Because of this the outputs will have changed which will likely drive new client specific recommendations.
So yes, market has ripped higher over the last few months, but I don’t see this as unusual.
As always, if you want to talk more on this, just reach out.
Additional Data: Each month I get asked by clients what additional resources I’m looking at. Please hear me in stating I’m not trying to predict anything whatsoever, just some of the interesting data I’m watching.
- Federal Debt as Percentage of GDP – I think all of us will agree that Debt in this country is a problem, it’s been a problem and it’s a growing problem. This chart by the Federal Reserve puts the debt payments in reference to GDP. Helpful to put this in perspective.
- Trillions in Money Markets – At it’s highest level every reported, there’s 6.3T in money market funds, up from 6.1T last month. In the investing market, this is called “Dry Powder.” These are dollars enjoying higher levels of interest than in years past. But ask yourself, what do you think will happen when/if the Federal reserve starts to cut interest rates and banks start paying less in interest on these accounts? Do you really think people will just continue to hold their funds with less interest, or do you think they’ll look for other alternatives to make money? My guess is assuming interest rates come down, these people will start to move some of these funds back into the broader market. So what do you think would likely happen to market prices if this does occur?
- Breakeven Inflation Rate - 5-Year Breakeven inflation rate is now 2.32%. When you study this chart, you’ll see it goes back to 2004. Gosh darn close to the long-term average.
- Federal Reserve Balance sheet – For months the Fed was following through on it’s statement made in May 2022 of reducing the balance sheet by 47.5 billion per month in months June-Aug 2022, then reducing the balance sheet by 95 billion per month. But, just recently, you’ll see the balance sheet spike up by 300 billion with the new bank lending program but then a quick reversal. We’re now down to March 2021 levels and declining.
Market Truths
1. The Stock Market cannot be consistently known or timed
2. The Economy (as you define it) cannot be consistently known or timed
3. Over the past 100 years, the market has returned 10.45% (with dividends reinvested). It’d be difficult for someone to achieve this return if they did not simply stay invested. Data Source
4. The average intra-year market decline is about 14% and the market drops 15% or more every 3 years. J.P. Morgan | American Funds
5. Investing in equities has historically been volatile, my guess is it always will be, however when you consider equities (using the S&P 500 as a proxy), Real Estate, short-term bonds and corporate bonds, over the long-term, equities continue to be the historical winner. To crystallize this point, just look for yourself NYU.edu.
Market Beliefs
1. Because the future cannot be known, we must embrace the belief that the world isn’t going to end during our lifetimes, and if it does, our money doesn’t matter
2. The world has continued to advance, since well before Jesus walked the earth, so assuming the world doesn’t end, it’s rational to believe the world will continue to advance
In closing: We of course cannot control what the market does from here and we cannot predict when the next market downturn will occur. But we can control our behavior to these outside events and continue to stick with our long-term investment strategy.
As always, if you have any questions/concerns please contact me.
David Hobbs, CFP®
Wealth Advisor | Owner
Hobbs Wealth Management
Standard & Poor’s 500 (S&P 500) - a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.
Russell 2000 – The index measures the performance of the small-cap segment of the US equity universe. It is a subset of the Russell 3000 and includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.
MSCI ACWI ex USA – The index measures the performance of the large and mid-cap segments of the particular regions, excluding USA equity securities, including developed and emerging market. It is free float-adjusted market-capitalization weighted.
Federal Funds Rate - refers to the target interest rate set by the Federal Open Market Committee (FOMC). This target is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
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