Why Dow 11,000 Is Worth a Lot Less Now Than in 2001

Dow 11,000The stock market is all about nominal prices. That is, prices that aren't adjusted for inflation or what analysts call "relative performance" -- how an investment has fared when compared with competing assets.

While this may seem like a parlor game, comparing how investments fare over time is a key element in portfolio management. Relative performance boils down to this: Sell assets that are historically overpriced, and buy assets that are historically underpriced.

The equities industry and the financial media tend to shy away from relative-performance analyses, and a few charts help explain this reticence. But in short, when adjusted for inflation, the stock market hasn't recovered as much as it appears to have when you look at only nominal prices.

Here's a 10-year chart of the Dow Jones Industrial Average (DJIA), which recently reclaimed 11,000, the same level it held about 10 years ago, in early 2001.



Adjusted for inflation (as per the Bureau of Labor Statistics), the Dow would have to reach 13,570 to equal the "purchasing power" value of Dow 11,000 in 2001. ($1 in 2001 equals $1.23 in 2010.)

Let's take a hypothetical investment in the Dow of $11,000 in 2001. That dollar amount equals the Dow's nominal price level. If a person has reinvested dividends from the $11,000 investment in the DJIA, that portfolio would now be worth about $14,066, based on the average Dow dividend yield of 2.66%.

So a "buy and hold" investor who reinvested dividends in the Dow for 10 years has stayed one step ahead of inflation, but not by much. The total return for a decade of ownership of the DJIA adjusted for inflation is a meager 3.6%.

Proponents of "buy and hold" have little to show for the past decade, and those who insist nominal prices are all that matters suffered a 23% decline in the purchasing power value of their portfolios, even though the Dow is near the same level it was in 2001.

Pricing Stocks in Barrels of Oil

Another way to perform a relative-performance analysis is to price an asset in something other than U.S. dollars. That might be gold, another currency or even a commodity like barrels of oil.

Let's say one "share" of the Dow equals its nominal price: If the Dow is 11,000, then one "share" is $11,000.

How many barrels of oil does one "share" of the Dow purchase? In 2001, the Dow was 11,000 and a barrel of oil cost on average $23. So one "share" of the Dow at $11,000 bought 478 barrels of oil.

If we adjusted that $23 per barrel for inflation, that price in 2010 would be $28.37.

How many barrels of oil would the current Dow buy at the 2001 price (adjusted for inflation)? One "share" of the Dow today ($11,000) would buy 388 barrels of oil priced at $28.37 per barrel. That means the Dow today buys 90 fewer barrels of oil than it did in 2001, even after adjusting the price of oil for inflation. That means the Dow underperformed oil by about 19% over the past decade.

But oil didn't just rise at the official rate of inflation. Today, the spot price of crude oil is $87 per barrel. So our one "share" of the Dow ($11,000) buys a mere 126 barrels of oil. So, compared to oil, the Dow has underperformed by a whopping 67%.

Put another way: $11,000 invested in oil in 2001 would have tripled, while $11,000 invested in the DJIA has either lost 23% when inflation is accounted for, or returned a modest 3.6% if dividends were reinvested.

What If You Were Paid in Silver?

In the early decades of the 20th century, my wife's grandfather was paid with a single gold coin. Just as a thought-experiment, let's say we worked in a silver mine and were paid in silver rather than U.S. dollars.

How would our pay just since July 1, 2010, compare with other investments such as gold, the S&P 500 and agricultural commodities? The following chart answers that.



Yes, the S&P 500 has soared 19% in nominal terms since July 1. But when priced in silver, stocks have lost a staggering 33% of their value in that period. When priced in silver, the U.S. dollar, undermined by the Federal Reserve's latest round of quantitative easing (QE2), has lost a stupefying 56% of its purchasing power value in just a few months.

Agricultural commodities have held their own when priced in silver, declining less than 1%.

The point of this exercise is to show that "value" and "price" are relative. What matters is not nominal prices but what your money and portfolio returned in inflation-adjusted terms -- and what your money can buy in the real world. This is why purchasing power is a far more important measure of value than nominal prices.

This insight is the basis of The Economist's tongue-in-cheek "Big Mac Index," which compares the cost of Big Macs around the world.

Those who benefit from selling and recommending equities avoid relative performance analyses for good reason: Stocks have performed poorly compared to other assets classes over the past decade. As investors, it's up to us to do our own relative-performance analyses to help us conserve and enhance the purchasing power of our portfolios.

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frank1946

Federal Government hates "Capital Formation" so they tax the hell out of business and savings..............9/11 just showcased the lack of liquidity in Capital Markets.............so the Feds continue with deficits, taxes and lies to make Joe Sixpack believe we are still the Greatest when we are not anymore ! China will own America by 2025 (or a mix of China and India) ! Wealth is produced by a low cost of Capital and Knowledge in Production, America seems to ignore this Rule for BIG DEBT and HIGH TAXES, a Fool's Game !

November 14 2010 at 9:33 AM Report abuse rate up rate down Reply
acc56

That was a TEST, SINCE you FLAG MY POST 9 TIMES OUT OF 10 and still charge me $25.00 a month.

November 14 2010 at 2:42 AM Report abuse +1 rate up rate down Reply
acc56

ccccccccccccccc

November 14 2010 at 2:39 AM Report abuse rate up rate down Reply
stag01987

Ladies and gentlemen, I have to go give my daughter a ride to her friends house over in another town. I'll look to see if any of you are still here when I get back in about 45 mins. If I don't get a chance to chat with y'all later on, I still wish you a good night!

November 14 2010 at 12:21 AM Report abuse +2 rate up rate down Reply
raspberries0

stag01987 12:09 AM Nov 14, 2010 --- Ever since that one night a few weeks ago, I haven't been posting much on here either. I still read, but I try to keep quiet unless I can come up with something I think is relevant to the topic or just to give a shout out to people I recognize. Been trying to stay towards the center. I don't find pleasure in personally attacking anyone just because their opinions are different than mine. I like to tease my friends if I can do it without pissing them off too much.>>>>>>>>>>>>>Me too. Haven't been on much. Turns my stomach to see some of the posts. Some from my side of the 'aisle' too.

November 14 2010 at 12:18 AM Report abuse +3 rate up rate down Reply
stag01987

Ever since that one night a few weeks ago, I haven't been posting much on here either. I still read, but I try to keep quiet unless I can come up with something I think is relevant to the topic or just to give a shout out to people I recognize. Been trying to stay towards the center. I don't find pleasure in personally attacking anyone just because their opinions are different than mine. I like to tease my friends if I can do it without pissing them off too much.

November 14 2010 at 12:09 AM Report abuse +1 rate up rate down Reply
raspberries0

Oops -- Sorry Stag. Was being attacked by an unsavory sort on another forum, but got off there. Too boring. A supposed conservative too no less!

November 13 2010 at 11:51 PM Report abuse rate up rate down Reply
3 replies to raspberries0's comment
stag01987

I don't do a whole lot of actual grilling myself ras. I don't have the patience to do it all the time. I do have one of those Ronco showtime rotisseries that I use quite a bit. It's just like you see in the informercial. Set it and forget it. It makes the best chicken I've ever had, besides my mom's. They're so easy to use and in the convenience of a warm kitchen!

November 13 2010 at 11:16 PM Report abuse +1 rate up rate down Reply
stag01987

It got quiet in here. Did I drive everyone away? Ras? Bushwas?

November 13 2010 at 11:09 PM Report abuse rate up rate down Reply
1 reply to stag01987's comment
raspberries0

I'm here, see below.

November 13 2010 at 11:11 PM Report abuse +1 rate up rate down Reply
stag01987

I haven't cooked anything special lately ras. Been using my bread machine though. Sometimes I make Italian herb and sometimes pumpernickel rye. Wabayaba did some cooking today! He grilled steaks and ribs. I got so hungry reading his posts I went and bought some for tomorrow!

November 13 2010 at 10:54 PM Report abuse +2 rate up rate down Reply
3 replies to stag01987's comment