The Stock Market Always Goes Up

The stock market always goes up over the long run. Over a short period of time, such as a year or possibly even a few years, it may not go up. In fact, over the short run the stock market can be extremely volatile. If you are brave enough to ride out these short term fluctuations it will change your life.

The graph above shows the Dow Jones Index over more than a 100 year period. The Dow Jones Index was set up in 1896 and tracks the stock prices of the 30 largest companies in America, which today includes Apple, Nike and McDonald's. Since 1896, there have been numerous economic recessions and two world wars. Despite this, the stock market continued its ascent and will continue to do so for the reasons below.

"The stock market isn't risky. The stock market only becomes risky when your holding period isn't long enough." - Brian Feroldi

1. Technological Advancements

Technological advancements and human ingenuity leads to companies being able to provide ever better products and services, which ultimately benefit society, subsequently raising the standard of living. In addition, as companies become more efficient they can often provide these products and services at a lower cost, making them more affordable to the general population.

For example, in 1970 an IBM mainframe computer (which took up a whole room) would set you back around $5 million in todays prices and would run at a speed of 12.5 MHz. Today, your average computer would set you back around $500 and would run at a speed of 4 GHz. In just over 50 years, computers have become 320 times faster and 10,000 times cheaper.

1970 - IBM Computer

2021 - Dell Computer

Real GDP per capita measures the material standard of living for the average person in a population. In Warren Buffett's 2015 letter to shareholders he stated the following - "American GDP per capita is now about $56,000. As I mentioned last year that - in real terms - is a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently and thereby produce far more. This all-powerful trend is certain to continue".

Advancements in technology clearly increases our productive capacity, which creates more value for businesses. This value creation, is one of the main reasons why the stock market has grown over the long run and will continue to do so. Human progress will never come to to a halt and is the main reason why the stock market will continue its relentless rise upwards, although it will be a bumpy ride along the way.

"If I have seen further, it is by standing on the shoulders of giants." - Isaac Newton

What Isaac Newton meant by this is that each generation's iterative improvements to our species, starting with our hunter gatherer ancestors developing language and control of fire, brought us here. Future generations will always lead a better life.

2. Natural Selection (only applies if investing in an index fund)

Index funds, are a collection of companies where when you invest in the fund, you are investing in a slice of every company in the fund depending on big they are. The S&P 500 index for example represents 500 of the largest companies in America, which include Apple and Microsoft. As of the 31st December 2021, the top 10 largest companies in the S&P represented 30.40% of the value of the fund. Therefore, if you were to invest £100 into the S&P 500 index, £30.40 would be going to these companies.

As companies grow or shrink within an index the amount of the fund that is weighted towards them changes too. If a company's stock market valuation shrinks too much they will actually exit the index, to be replaced by a company who has been growing. As Jim Collins puts it "The market is not stagnant. Companies routinely fade away and are replaced with new blood."

This is the magic of an index fund because the worst possible performance of a stock is losing 100% of its value. There is no upside limit to the best possible performance of a stock because a growth rate of far more than 100% is entirely possible.

The graph below shows the average length of time that a company will be included within the S&P 500 index. Over the next 5 years this is expected to be between 15 and 20 years. Between 2018 and 2020, 38 under performing companies were dropped from the index and were replaced by companies such as Tesla.

3. Inflation

You may have guessed it already but an underlying reason as to why stock prices rise over time is due to the general rise in prices within an economy as a result of inflation. A rise in prices, increases a companies revenue and profits, with their stock price rising as a result. This is not real growth, it is only nominal growth.

The graph below shows the long term rate of inflation, which has been on average 3%. The S&P 500 index has historically returned 10% a year. This is its nominal return (not adjusted for inflation). When inflation is taken into account its real return is roughly 7% a year.

US Inflation Rate 1920 - 2021

4. Population Growth

Rising populations in particularly Africa and Asia, coupled with advancements in healthcare means people are living longer with the global population expected to reach almost 11 billion by the end of the century.

In a nutshell, if a company can sell more things to more people, this will lead to more profits. Therefore, companies share prices will continue to climb and its distributable profits to shareholders in the form of dividends will be greater.