All Terrain Thinking

A Compendium of things I think are Important
"If you teach a man to think he is thinking, he will love you. If you teach a man to think, he will hate you. - Ed McArthur"
 
 

Economics: It's not just whats' in your wallet

Stock prices: A closer look at inflation

We have examined a variety of price and quantity measures in the output and labor markets and now we will turn our attention to the capital market. At this time we will direct our attention to the question: How has the capital market performed? A complete review of the wide array of capital markets would be well beyond the scope of this analysis, but we can look briefly at two important prices - stock prices and interest rates which are related to the price of bonds.

What has happened to the price of stock?

When we talk about the performance of stocks, the price of stock quoted is generally some average of the prices of a market basket of stocks. In this sense it is very much like the CPI which is a weighted sum of prices. The various measures you hear about in the nightly news are simply different market baskets. As you can see in the following diagram, the various indexes tend to move together but the fit is not a perfect one. By 1996, the NYSE Composite was nearly 17 times greater than it was in 1955, while the Dow Jones Industrial was approximately 13 times larger. In both cases, however, we saw a general increase in stock prices for the entire period.

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What happens when you account for inflation? There is no question you cannot buy as much with a dollar today as you could 10, 20, or 40 years ago and thus the increase in stock prices overstates the return on the investment.  For example, during the period 1955-1996 some of the increase in the price of stock could be attributed to a general increase in the price level. If we were to 'correct' the stock price data to reflect changes in the level of overall prices [the technique is the same as you would use to adjust wages / earnings] we would see a substantially different picture. In the late 1960s, the real price of stock began a decline that did not end until the early 1980s when it began its latest rise.

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