The stock market has been making headlines recently with the Dow Jones Industrial Average (DJIA) reaching 40,000 for the first time. However, while this may seem like a positive sign, inflation can significantly overstate growth and improvement. When adjusting for the 21.1% cumulative inflation during the Covid period, the 40,000 level actually becomes 33,000, reaching this level three years ago in 2021. This highlights the potential misleading effects of inflation on the stock market.
While the DJIA has yet to break through its 3-year-old high, other indexes such as the S&P 500 and Nasdaq have also seen new highs. However, when factoring in inflation using the Consumer Price Index (CPI), the picture changes significantly. The inflation-adjusted indexes show that the new highs disappear, creating a mix of hope and concern for investors. This demonstrates the impact of inflation on stock market performance and the importance of considering the real adjusted levels.
The outperformance of the S&P 500 and Nasdaq compared to the Dow can be attributed to market capitalization weightings and the favorability of large companies and growth stocks. However, there is a warning in these differences, as it reflects a return to previous patterns seen in 2021. This raises the question of whether the current stock market environment is forming a new bull market foundation or if a reversal could be looming.
The media’s portrayal of the stock market as being in a new all-time high growth phase may not fully capture the real impact of inflation. Adjusting for inflation reveals a different picture that contradicts the optimistic narrative. It is essential to be a careful realist rather than an enthusiastic optimist in such market conditions. The discrepancy between reported and inflation-adjusted levels highlights the need for investors to consider all factors when assessing the true performance of the stock market.
As the market continues to reach new highs, investors should be wary of the potential effects of inflation on these levels. Being a contrarian when the media is overwhelmingly positive about the stock market can help investors make informed decisions based on a more realistic assessment of market conditions. By understanding the impact of inflation and considering the adjusted levels, investors can navigate the stock market with a clearer perspective and avoid being misled by inflated figures.
