Adjust Indexes For Inflation?

[Telly]

I tuned in to Kudlow & Co. earlier this week, and caught a guy with a British accent who was very interesting. Didn't get his name, as I missed the beginning of that segment.

He was not impressed with the recent runup numbers, said that the previous high for the S&P 500 of 1527 in March 2000 (1527.46 on 3/24/00 I read in a newspaper) needs to be adjusted upwards for inflation to be applicable for today. He was going to say more, when Larry talked over him, and then they went on to something else.

I guess I never really thought about inflation's effect on indexes. If the index represents the stock prices of the constituent equities, then it would seem that the number of dollars needed to buy the stock today are inflated dollars versus the dollars of the past.

So to make an index relevant over time, we really need to adjust it for inflation, right? This could be done using CPI-U for the S&P 500, but for an international index, what a mess!

 

[saluki9]

We do it all the time.

Our software package just pulls your preferred inflation measure from the index returns.

Also, for non US indexes your relevant index is still your country specific index since that is where you spend your $$$

 

[Nords]

So to make an index relevant over time, we really need to adjust it for inflation, right? This could be done using CPI-U for the S&P 500, but for an international index, what a mess!

And then would you be reinvesting those dividends in taxable or tax-deferred accounts?!?

 

[Telly]

Using the latest CPI-U index figures available (March 2007), I adjusted the previous S&P 500 high of 1527.46 in March 2000 upwards to account for inflation over the years.

March 2000 CPI-U index = 171.2
March 2007 CPI-U index = 205.352

So the inflation-adjusted S&P 500 high to match would be 1832.16. Far from today's ~1509!

At the present ~1509, it's only at ~82% of the previous high, adjusted for inflation. So let the good times roll

 

[jIMOh]

you don't invest in the index directly... you invest in a mutual fund which buys securities in the index in some weighted fashion.

The index is "points" not dollars. If I bought one share in each of the 500 companies of the S&P 500, it would cost me much more than $1400 or $1500.

 

[Telly]

If you bought one share of each of the companies in the S&P 500, you would be making your own whatever index, certainly not the S&P 500. The S&P 500 is not a list of 500 stocks. It is a calculation.

See #3, especially the second paragraph, and #7 in the following document:
http://www2.standardandpoors.com/spf/pdf/index/FAQ_US_updtd_mfm%20edits.pdf

Also see this document for much more detail:
http://www2.standardandpoors.com/spf/pdf/index/SP_US_Indices_Methodology_Web.pdf

The US Dollar is used in calculating the index. So, if over the years the US Dollar inflates, the effect on the index is...

 

[Gone4Good]

So to make an index relevant over time, we really need to adjust it for inflation, right? This could be done using CPI-U for the S&P 500, but for an international index, what a mess!

It's the difference between Real and Nominal returns. For simplicity almost everyone talks about Nominal returns. But it is only Real returns that matter.

 

[chinaco]

I believe the S&P 500 experienced a run up that was part of the bubble. It was overpriced during the years from 1993 - 2000. It almost doubled twice in 7 years from around 400+ to 1500. It's historical average (10.5%) would have it doubling every 7+ years. I believe we are about where we should be in the 1500 range. Think regression to the mean!

I have read several predictions of an S&P @ 1600 around the end of this year. That would put it on target for the long-term trend.

The value at the year 2000 plus a compounded CPI inflation rate would put it ahead of where it would normally be.