The inflation adjusted chart shows the true nature of the U.S. stock market.
Note the following about this chart:
- Dividends are excluded, so the chart only shows capital gains. The dividend yield of the S&P is running near 2%. (IndexArb.com)
- The inflation rate used on the chart is the government CPI number until 1993. Beginning 1994, I have added 2% per year to the government CPI number. This should better reflect the true inflation rate since the government number has not been accurate since around 1993. Articles claim that the geometric weighting formula used by the government to calculate CPI incorrectly subtracts 2.7% from the true the CPI. The government does other adjustments that constitute another 4% reduction in the inflation figure. It is my judgement that most of the adjustments are valid; however, the CPI seems to understate inflation by about 75% of the geometric weighting formula. This is why I have settled on a 2% adder. For more information on inflation, see the following articles: http://www.shadowstats.com/article/56 , http://www.safehaven.com/article-8848.htm
On the chart, the long term trend line in green shows an average return of 1.9% per year. If you factor in the long term 15% capital gains tax, the return is even worse. Since capital gains tax is not adjusted for inflation, the average tax must be based on the 5.4% trend of the non inflation adjusted chart, so 15% of 5.4% is a 0.8% tax. Therefore, your 1.9% return is reduced to 1.1% after taxes. Most people have no idea that this meager amount of capital gains is all they should logically expect from a long term general stock market investment.
The Dow has historically moved within well defined channel. The boundaries of the channel have been touched only 4 times since 1910. The top of the channel was last touched in 2000.
They say "the market always goes up in the long term," but at an average return of 1.9% per year, it can take many years to recover from a large decline. The peak in 1929 was not ultimately exceeded until 1992. When the market touched the bottom of the channel in 1982, its value was about equal to the value at the beginning of the chart in 1910.
Most bubbles eventually correct back to where they began. The bubble that began in 1922 gave back all its gains by 1933, and the bull market that started in 1949 gave back almost everything by 1982. The bubble that ended in 2000 has already corrected back to the 1995 level. The correction could easily continue to the 1988 level of 6000. If the Dow hits the bottom of the channel, it would go to about 5000. Keep in mind that these are values in today's Dollars, so the future values after inflation will be higher.