Strangest Graph You’ll See All Day

Bear with me on this one. The long-term evidence suggests that the stock market’s total return outperforms inflation by about 7% a year (or doubling in real terms every ten years). That’s of course an average—the stock market has been dead flat against inflation for 12 years now.
Here’s a look at the stock market’s real total return, meaning with dividends and adjusted for inflation, divided by a line rising at 7% a year. In other words, a flat line is a real increase of 7% a year.
Just to make things even weirder, I used a log scale. The idea is to get the purest measure of the stock market’s performance.

Since earnings growth tends to be fairly consistent, this line is surprisingly similar to a graph of price/earnings ratios. Of course, there’s no guarantee that stocks will continue to outperform inflation by 7% a year.
What I find interesting is that the peaks and valleys seem to line up well. Warning: It’s dangerous to see relationships where none may exist. Still, it’s kind of interesting. I think it’s also interesting to see that there are very long periods of out-performance and under-performance. Stock investing is hardly a game for all seasons.

Posted by Eddy Elfenbein on May 1st, 2009 at 2:59 pm

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