Ronald Reagan, in his first run against Jimmy Carter, is well remembered for asking voters whether they were better off than four years earlier. Given that the Dow Industrials broke into record territory, investors might also ask whether they are better off than nearly five and a half years ago, when the Dow last hit an all-time high.
Unfortunately, the answer is no—not by a long shot. For one, the effect of inflation has eroded the value of the dollar. On an inflation-corrected basis, the Dow would have to hit 15,640 to be worth more than it was in October of 2007. In fact, October 2007 was not even the Dow’s highest point in constant dollars. At the peak of the bull market in January of 2000, the Dow was just over 16,000 in today’s dollars, more than 11% higher than today. For the much broader S&P 500 Index, its inflation-corrected peak of March 2000 was 2,060, more than 30% above today’s levels.
But investors have fallen even further behind than these numbers imply. Because of the Federal Reserve’s policy of maintaining interest rates near zero, a dollar’s worth of savings does not go nearly as far as it did before the financial crisis.
For example, in early 2000, when the U.S. stock market was at its peak, an investor with a $500,000 nest egg in stocks could cash out and invest the proceeds in 30-year Treasury Inflation-Protected Securities (TIPS) yielding more than 4% and generate an inflation-protected income stream of about $21,000 per year. Unfortunately, at today’s near-zero rates, that same investor could obtain only $2,600 of annual inflation-protected income from his $500,000 nest egg, more than 87% less than in 2000.
This means that once inflation and lower interest rates are factored in, the stock market would have to rise to many multiples of its current level for an investor to enjoy the same after-inflation income today as he did 12 years ago.