Historical stock market prices (SP500)

Studying stock market indexes gives a good indication of the average stock market return. This helps us to set realistic expectations for investment returns. In fact, the efficient market theory tells us that despite what an investor does, his/her stock market return is likely­ will closely match the broad indexes as long as the investor is diversified to 20 or more stocks. This site does not advocate index investing but studying indexes does reveal invaluable information on price stock market price development and valuation.

Figure 1 shows the price development of SP500 index for the last 100 years. SP500 is a widely followed US stock market index that comprises of 500 large publicly traded companies. Since the great recession of 1920s, the SP500 has been advancing on average of little over 6% per year. Before 1920s, the stock prices were fairly flat but this does not mean that the investors were not rewarded; the stocks still gave healthy dividends to owners. Only more recently (and foolishly) have investors focused on price appreciation instead of dividend income.

Figure 1: Historical SP500 stock market prices and the annual SP500 price appreciation rate.

While the 6% gain per year for the SP500 sounds good, it is not guaranteed. There have been several long periods declining prices some lasting over ten years. Accounting for inflation, the performance is even bleaker: Figure 2 shows that the inflation adjusted prices have been rising on average of little over 3% per year which is a far cry from 10-20% expected by Wall Street believers. Without the dividends boosting the total return (dividend yield + price appreciation), the stocks would be have been a huge disappointment for the last 100 years!

Figure 2: Inflation adjusted SP500 stock market prices and the real inflation adjusted annual SP500 price appreciation rate.

Herein lays the problem with index investing. The index investing advocates point to past index performance without pointing the obvious: The past performance is partly due to dividends and partly due to stock market bubble that is still deflating. With the dividend yield near historical low at low 2%, the future performance may not reflect past performance.

In summary, stocks indexes are good educators but they can be terrible investment vehicles. This is especially true during the periods of high inflation.