Inflation Adjusted Dow Jones Averages
Dow 7000, Dow 5000, Dow 3000? Where will it all end?! I’m sure most of us have read numerous predictions about where the market is headed. Relatively optimistic market observers believe we are close to a bottom already, while others have been as pessimistic as to suggest that the Dow could fall all the way to 3000, or even further!
I have read a few commentators try to pinpoint a certain time frame that represents the real value of the Dow before a huge multi-year bubble developed. Some have suggested the bottom is near the late 2002 bottom, others have suggested the market will reset itself to the mid-90s; a few have even argued that the market will fall back to 1990 or even 1982 levels!
While some of these predictions seem far-fetched, it did make me curious to examine inflation-adjusted Dow Jones Industrial averages (DJIA) from the past in order to try to assess how realistic some of these predictions are and see if any trends or patterns emerge.
In order to go about this task, I have examined the DJIA at the beginning of certain selected years and adjusted those figures for inflation using historical inflation data from the Bureau of Labor Statistics. While I have selected numerous years for examination, I have attempted to mostly use center points, or that is, periods where the market was roughly halfway between highs and lows. Occasionally, I have picked out other years I believed might be relevant. The 1930s
For the 1930s, I decided to examine the DJIA starting at three different points: 1931, 1934, and 1937. 1936-37 marked a brief boom for the market before the uncertainty of world war stifled returns for nearly a decade. As such I felt as if it might be more representative of the future than some of the more dismal results from the Great Depression.
Both the 1931 and 1937 inflation adjusted results overshoot the actual Dow until the early 1950s. By contrast, the 1934 inflation adjusted results seem to be fairly predicative of general market averages from 1943 to 1951. At the start of 1944, the DJIA stood at the 140 level, while our inflation adjustment churns out a prediction of 143. In ’48, the Dow traded at 180, while the inflation adjustment predicted 195. Then in 1951, the Dow traded at 200 while the inflation adjustment gave us 211. All in all, using the 1934 DJIAs to gage the market’s future worked fairly well until about 1953. After the mid-50s boom, however, 1934 loses its value as a predicative benchmark. Indeed, even the more generous ’31 and ’37 averages undershoot everything from 1955 onwards!
One more thing of note here --- it’s interesting just how devastating the effects of deflation were on the market during the Great Depression. At the beginning of 1931, the Dow was trading around 170. Going solely by inflationary adjustments, it would not reach that predicted level again for another 11 years in mid 1942! Hence, even if real economic growth had been occurring during this time period, many of those playing the market might have taken significant losses simply due to the effects of deflation. 1955
Due to the fact that the huge uncertainties in the global political climate created more risk than might be present during the past half-century, it stands to reason that the 1930s might not be the best period to create a predicative model for the more modern times. Even the Cold War never produced as much uncertainty as the Great Depression and World War II as both events simply battered the market for over a decade and a half. In any case, if we used 1937’s inflation adjusted results to predict a market average for 2007, we end up with a Dow trading around the 3,000 level. Let’s hope we’ve had real economic growth since then and we’re not dropping that far!
1955 marked the beginning of a boom that arguably stretched from the early to mid ‘50s all the way until the late ‘60s. For this reason, it seems particularly pertinent to the modern time since one could argue that we entered a boom period that stretched on from the late ‘80s or early ‘90s, all the way till 2007!
Due to the rapid rise of the market in the ‘50s and ‘60s, 1955’s inflation adjustment results undershoot the Dow for the subsequent 18 years before becoming a moderately successful predicative indicator of the troubled market in the mid ‘70s. In ’74, the 1955 adjusted results predict a Dow Jones average of 734, while the actual market began the year at 830 and worked its way down to 600. The ’55 adjusted results are spot-on for 1976 predicting a value of 848, while the actual market traded within points of that level.
However, the high rate of inflation in the late ‘70s coupled with virtually no growth in the Dow come together to erode 1955’s predicative ability as it overshoots the actual Dow average dramatically until the mid ‘80s. 1955’s inflation adjusted results once again align with the market in 1988, before undershooting the market dramatically as a result of the ‘90s boom period. Inflation adjusted 1955 results predict that the DJIA should trade around 3,400 at the beginning of the upcoming year, which isn’t really much of an improvement over our 1937 prediction. The 1960s
The rapid market growth in the ‘60s breeds a few interesting years to select from. I decided to look at 1961, 1964, and 1968. The inflation adjusted results from these three years dramatically overshoot the actual Dow average for most of the 1970s and ‘80s. However, all three years (particularly 1964) end up being very excellent predictors of the DJIA from 1990-1995.
The Dow began 1990 close to the 2,750 level and the 1964 inflation-adjusted Dow would show a result of 3,290. Over the next six years, the actual Dow and the ’64 inflation-adjusted Dow stay in the same average trading range. In ’95, the actual Dow started at about 3,800 while the ’64 inflation-adjusted Dow predicts 3,835, which is almost spot-on! However, a significant upswing in the market in ’95 and the late ‘90s boom ruins the magical predicative value of the ’64 Dow.
The ’64 inflation adjusted Dow gives a result of 5,750 for 2009 dollars. Also of note, the ’68 Dow gives a result of 6,250 for 2009. This might suggest that the ultimate pessimists who believe Dow 3,000 is coming are either unrealistic or believe that the American economy has actually regressed substantially since 1968. At the same time, the thought that the Dow could drop all the way down to the 6,000 level is a frightening thought. The 1970s
It’s time to take a trip back to the world of stagflation and bell-bottoms: the 1970s! I picked out three years from that decade to examine: 1974, 1976, and 1978. The ’76 and ’78 inflation adjusted Dow averages seem to be a fairly good predictive indicator until about 1989 or 1990, which might arguably suggest that there was very little real growth in that time frame. After ’90, the ’76 and ’78 inflation adjusted Dows significantly undershoot the actual Dow during the ‘90s boom years. The ’74 Dow, by contrast, overshoots the actual Dow till about 1989 and seems to be more in line with the Dow from 1990-1994 before it, too, significantly begins to undershoot the actual Dow.
If you believe we’re headed back to the mid 70’s, the ’74 inflation adjusted Dow yields a result of about 4,300 while the ’76 Dow produces a result of 3,614. The ’78 Dow produces a dismally low 2,900, which is interesting in that this result is actually worse than our result for the ’37 Dow. 1982 & 1988
The ‘80s produces some interesting data but perhaps not in the way I anticipated. I decided to examine 1982 and 1988 for my sample.
1982’s inflation adjusted returns lag the actual Dow substantially at nearly every point onward. In 2009 dollars, the 1982 Dow sat at a paltry 2,265, which amazingly enough, ends up being worse than two out of our three Great Depression years (1931 and 1937). It still managed to beat out the ’34 inflation adjusted Dow, however, which stood at a horrific 1,866.
Examining things from this perspective, perhaps it could be argued that the boom that stretched from the late ‘80s all the way till this decade was at least in part, an overdue market correction. After all, as bad as things were in 1982, were American companies really in worse shape than during the Great Depression?
1988’s inflation adjusted returns also substantially lag the actual Dow every year afterwards. In 2009 dollars, the ’88 Dow traded around the 3,625 level, which means if you believe we’re due for a return to ’88, we have a lot of pain to go! The 1990s
One way to think of the 1990’s might be to recall James Cagney’s role in 1949’s “White Heat”. At the end of the film when the law has caught up with Cagney’s character, we find him at the top of a building in a fiery blaze screaming out, “top of the world, ma!” Likewise, the ‘90s was sort of like climbing to the top of a fiery inferno to meet our demise in the most dramatic fashion.
I decided to examine four years from the Boom Decade: 1990, 1995, 1996, and 1997. The market gradually ascended during the first five years (till around early 1995) before climbing to otherworldly levels. 1990 and ’95 have not had much predicative impact thus far. 1990 inflation adjusted returns yield a Dow average of around 5,075 in 2009 dollars, while ’95 yields an average of 5,860.
1996 and 1997 are intriguing in that the inflation adjusted returns for those years come fairly close to predicting the current state of the Dow. 1996 gives us a Dow at 7,800 to start of 2009, while 1997’s inflation adjusted returns gave us a Dow average of 9,000 for the beginning of 2008 and 9,475 for 2009. Not that far off, eh? Only time will tell if we stay around the ’96 and ’97 levels for any deal of time into the future. Predicative Value
While there were a handful of results that were moderately predicative, for the most part, it’s very difficult to gage where the market stands in relation to a prior time period based solely on official inflation numbers. Obviously market volatility is one of the major factors behind this, but even over the long-term, it becomes clear that the inflation adjusted Dows don’t even predict a running average for future Dow with any degree of consistency for the current times. I have numerous thoughts on why this might be the case:
(1) Inflation is understated – If former Fed Secretary Paul Volcker is correct and inflation using the official government figures has been understated over the past decade or two, this might impair our results significantly since we should expect greater market appreciation than the official inflation figures might predict.
(2) Real economic growth – This one is a no-brainer. If real economic growth occurs, inflation alone would not be able to predict results in future years based on this. Given the advances in technology over the past few decades and increasing efficiencies that have resulted from it, it can certainly be argued that we have experienced significant real economic growth in recent decades.
(3) Taxation policies – Tax policy shifts have almost certainly helped fuel market growth. The government has embarked on a policy of shifting the control of more and more resources to the private sector over the past half-century. This has occurred via cuts in the corporate tax, capital gains tax, dividend tax, and even individual income taxes. Taking a look at tax rates in the early 1950s and comparing them to the present day shows a very dramatic change. It should be expected that such a mass shift of societal resources to the private sector would result in a greater aggregate market value, which would be reflected in the Dow. As such, perhaps we shouldn’t be surprised that valuations tend to be higher in modern times.
(4) Risk adjustment – Numerous individuals believe the Dow Jones Averages to be a reflection of economic strength during a certain time period. However, this might not be as true as many people would like to believe. Even ignoring the aforementioned factors, an examination of our results suggests that the market significantly lags in periods of great uncertainty. This makes sense as elementary finance teaches us that people will demand greater returns to offset such uncertainty. The Great Depression, World War II, and the mid-70s recession years all stand out as periods where the market more or less traded sideways for years before a huge boom period eventually followed. This might indicate that even if real economic growth occurred during these times, the market might not have reflected it until later periods when risk was perceived to be diminished.
All in all, the inflation adjusted Dow averages are interesting to look out, but for the reasons outlined above, perhaps we should expect the current Dow to trade at a significantly higher range.
For those interested, here are the inflation adjusted Dow averages for all the years I examined, translated to 2009 Dollars (rounded to nearest multiple of 25):
1931 – 2,350
1934 – 1,875
1937 – 2,975
1955 – 3,400
1961 – 4,800
1964 – 5,750
1968 – 6,250
1974 – 4,275
1976 – 3,625
1978 – 2,900
1982 – 2,275
1988 – 3,625
1990 – 5,075
1995 – 5,850
1996 – 7,800
1997 – 9,475
2003 – 10,175