The Meaning of the New Highs in the S&P500

The S&P500 has recently been hitting new all-time highs, which would seem to suggest that the economy is recovering and that the U.S. economy is back on track.  The story does not look quite so rosy when you account for inflation, as Mark Hulbert has recently noted.  The current level of the S&P500 is, in fact, still about 24% below its high in 2000 once inflation is considered.  Economists and finance people would say that, measured in real terms, the S&P500 is 24% lower than it was at its 2000 peak.  What this means is that the proceeds from the sale of a share of an S&P500 index fund purchases considerably less in real goods today than it did thirteen years ago. 

When you buy a share in an S&P500 fund, you are getting two things.  First, you are getting rights to future dividends, which are the distributed earnings of the firms that make up the S&P500.  Second, you are purchasing an asset that may or may not be worth more in the future.  Hulbert’s point is that while the dollar value of a share in an S&P500 fund has now exceeded its previous all-time high, you will be able to buy 24% less goods and services with the money from selling that share than you could in 2000.  Hulbert notes that an investor who used all dividends to buy more shares of the S&P500 would have considerably more in terms of actual purchasing power, but that even this investor would have assets that were worth less in real terms than they were worth in 2000.

Let’s frame this situation in simpler terms.  Imagine that instead of buying shares in the S&P500, you bought a rental property in 2000 for $100,000.  The rent that you collect is the equivalent of dividends.  Imagine that you had reinvested all of the rent that you have gotten over the years in maintaining the property, paying property taxes, and making improvements to your property.  You decide to sell your property this year, and you find that after paying the realtor, you will pocket $135,000.  Have you done well or not?

I chose the $135,000 figure because this how much money you need today to match the purchasing power of $100,000 in 2000.  So, you have taken risk and invested for thirteen years and, at the end of it all, you have the same purchasing power as you did back in 2000.  Hulbert demonstrates that investors in the S&P500 have actually done a bit worse than this.  Even with reinvested dividends, the S&P500 is worth less today than it was in 2000 in real terms.

In inflation-adjusted terms, you can buy a share of the S&P500 today for about the same price as you could in 1997.  What this means, in turn, is that the index as a whole has not generated a net-of-inflation return for investors (beyond dividends) from 1997 to today.  What has happened to all of the reported earnings that have not been paid to investors via dividends?  In terms of the current market values, these net earnings have not generated value for shareholders and this is perhaps the most significant conclusion.  The current market levels suggest that the value of the economy, as measured in terms of the value of the companies represented by the S&P500, is about where it was in 1997.  This is not terrible news, but neither is it reason for celebration.

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