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:
Innovation
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.
Inflation
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.
Population 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.
Natural selection
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.
Bottom Line
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.
George Maroudas
847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor
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
Stock investing includes risks, including fluctuating prices and loss or principal. This information is not intended to provide specific advice or recommendations about any stock nor is it intended to be a recommendation to buy, sell or hold any stock investment. We suggest speaking with your financial professional about your situation prior to investing.
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.
Investments in real estate may be subject to a higher degree of marker risk because of concentration in a specific industry, sector, or geographical sector. Other risks can include, but are not limited to, declines in the value of real estate, potential illiquidity, risks related to general and economic conditions, stage of development, and defaults by borrower. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Treasury Inflation-Protected Securities, or TIPS, are subject to market risk and significant interest rate risk as their longer duration makes them more sensitive to price declines associated with higher interest rates.
