The Power of Inflation on the DOW

Happy Thursday to all!

I have talked a lot about inflation recently, and I wanted share a couple of interesting graphs that I picked up from Itulip.com.

The author of this graph(who was not named) has done some sophisticated calculations on the real return on the DOW since 1924. Including inflation, the DOW has historically returned 1.64%. How bad is that!! Wall St. doesn't like to include inflation when they brag about their outrageous returns over the years when they are talking you into buying stocks.

If you look at history, for ever great run that the pigmen have had of 15-20% type returns, there is a downturn where they get creamed. A good example of this is the 50% drubbing they took on the S&P during the dotcom bust. When all of these deviations from the mean get averaged out including inflation 1.64% is not too impressive is it?

Now what I want you to focus on here is the returns during the last prolonged period of inflation in the 1970's. As you can see the DOW performed WELL below the historical 1.64% average annual return of an inflation adjusted market. In fact, the DOW pretty much got killed throughout the whole period.

Now lets take a look at another chart:

I often talk about the great debt bubble, and both of these graph illustrate how massive this bubble has become. We often talk about housing prices reverting to the mean, and folks, its really no different when it comes to the stock market.

As you can see there is a double top here. We hit it first in 1999(tech boom) and then again in 2008. How did we get back up here? The bull market fueled by the housing boom!! As you can see, the debt party which started in 1994 with the tech debt bubble, pretty much lasted right through the housing debt bubble with a short sharp recession in between.

Well now we have a couple of problems. First we have ran out of bubbles to blow up and we are in debt up to our eyeballs. The second is inflation.

Inflation is back!

This is the bigger problem we have in the future. Almost every economist has admitted that going forward, inflationary forces will be a major headwind for the economy.

A look at the charts above tells you how devastating this can be to an economy.

Itulip has 3 paths back to the mean in the second chart. If path 1 is chosen, we will see a 40% drop in the DOW to get back to the historical mean of 1.64% inflation adjusted growth on the DOW. The other option is the DOW will drop to a lesser degree, and we wait years for the 1.64% growth to catch up to where the DOW sits after more moderate drop. This is doubtful IMO.

Bubbles almost always seem to end violently. Time will tell.

Either way, equities do not look like a very good investment going forward.

More importantly, with the threat of inflation, the risk of a significant drop in stocks is probable when you look at what happened in the 1970's.

History always repeats itself.