There’s nothing the stock market has yet to overcome. We’ve seen two world wars, a depression, multiple recessions, pandemics, and more. Why does the stock market continue to go up over the long term? Here are a few answers:
The pace of innovation has been one of the biggest contributors to stock market returns. Technological progress has continued for the lifetime of the stock market and for almost all human history.
Even in our everyday lives we have seen massive technological improvements. Twenty years ago, the thought of having a supercomputer in your pocket would be unthinkable. Now millions of people can access endless amounts of information and connect with people across the world with a smartphone.
As technology advances, so does productivity. S&P 500 companies are 70% more labor efficient than they were in the 80s. Simply put, these companies are doing more with less.
The stock market is a place where you can invest in human ingenuity. It is a bet on the future being better than today. Think of it as a way to invest in intelligent people and businesses as they continue to innovate and grow.
People are constantly looking for ways to hedge inflation and stocks are one the best ways to do that. As an investor, your asset prices get to ride upward with inflation.
Recently, food costs have gone up and companies are making their customers pay for the higher costs. One notable example is the largest fast food chain in the world (McDonalds) raised menu prices by an average of 6%.
When prices steadily rise, companies generate higher revenue. Therefore, part of the rise in the stock market can be attributed to inflationary growth.
As of January 2021, we have 7.8 billion people in the world and we are projected to reach 10.9 billion people by 2100.
A company that sells its products to two million people is more valuable than a company that can sell its products to one million people. With a larger population, companies typically have a larger market for their products and services.
In general, a larger population generates more economic productivity and growth which leads to larger and more valuable companies.
When looking at the stock market we often gauge performance by referencing indexes like the Dow Jones and the S&P 500. A common feature of these indexes that is overlooked is the selection process.
This chart from Rosenberg Research, shows how the Dow would perform if the components hadn’t changed since 1997.
Many people think the indexes are unchanging, but stocks that make up both the Dow Jones and S&P 500 index are selected by a committee. It includes a subjective criteria that includes “financial viability”. Underperforming stocks are cut and new, more innovative companies replace the old ones.
The indexes are not a good reflection of how your local coffee shops are doing. Instead, it represents how some of the largest and most profitable companies in the world are performing.
Think of all the changes businesses made during the pandemic to generate revenue. When employees couldn’t meet in the office, they met virtually. When people couldn’t go to movie theaters, companies launched movies on their streaming platforms. When people couldn’t go to stores, companies expanded curbside pickup and delivery options.
Corporate America doesn’t rollover when confronted with new challenges. Great businesses pivot and find ways to continue to grow and innovate. As revenue grows, so do earnings, and earnings ultimately drive stock prices over the long term.
Disclaimers and Sources:
S&P 500 Dow Jones Selection Process: Link here
McDonalds Raising Prices by 6%: Link here
Dow Chart from Rosenberg Research: Link here
Pew Research Center population growth: Link here
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Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy ensures success or protects against loss. This information is not intended to be a substitute for specific individualized tax advice. The Standard & Poor’s Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
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