Will Markets go up - You decide.

If we look at the S&P 500, a stock market index that tracks the stocks of 500 large-cap U.S. companies and is used as a benchmark of the overall market, it is obvious that it keeps going up. Since 1950 to 2020, the S&P 500 has grown by a tremendous 22,190%. Despite wars, pandemics, and every sort of crisis thrown in, the market keeps rising. It has consistently outperformed the Real Estate Market except for the period between 1990 and 2006. The reason that some feel more comfortable in the Real Estate Market is simply because the Financial Markets have more ‘boom and busts’.

Let’s look at what makes markets go up and why so many people lose money despite that trend. And this pattern tends to hold true not just in the U.S., but in many major economies around the world as well, including China, Germany, UK, India, Canada and South Korea. Over the long term, stock markets tend to rise. But why is that?

We first need to define what the ‘stock market’ is. When you hear that the stock market rose 1% today, it normally refers to a stock index. A stock index, like the S&P 500, is essentially a basket of stocks that does its best to represent the overall stock market. It includes stocks from various sectors of the economy including IT, Healthcare, Financials, Consumer Discretionary, Communication Services, Industrials, Consumer Staples, Energy, Utilities, Real Estate, and Materials. The index is also weighted according to market cap, so the larger companies constitute a larger proportion of the S&P 500. The top 10 largest companies account about to 28% of the S&P 500’s weight.

Here are the four reasons why markets go up: 

1. Inflation

That may sound hard to believe right now with sky high inflation and markets just finishing the worst first 6 months of a year in a long time, but Inflation is defined as the general rise in prices of goods and services in the economy. When prices steadily rise, companies generate higher revenue and profits over time. And when companies increase their revenue and profit, their stock value grows accordingly. So, part of the rise in stock index levels around the world is simply inflationary growth. Inflation is also one of the reasons why it’s better being an investor compared to a saver. As an investor, your asset prices get to ride upward with inflation. But as a saver, the value of your money only diminishes over time. However, that only holds true when inflation is mild. According to the U.S. Federal Reserve, an annual inflation rate of 2% is beneficial to the economy. Runaway inflation as seen currently will cause uncertainty, stifle economic growth and push investors to look elsewhere for opportunities.

2. Population growth

As of January 2021, there are an estimated 7.8 billion people living in the world. And this number is expected to grow before topping off at 11 billion by 2100. A higher population typically means a larger addressable market for companies. And companies that successfully sell to a larger, growing market become more valuable over time. A larger population can also support more specialised workers and industries. For example, a small developing economy of one million people may mainly comprise industries in agriculture, manufacturing and raw materials. But a larger, more advanced economy of 100 million can boast specialised industries in technology, communications, finance, retailing, entertainment, tourism, professional services, etc.

Of course, there are smaller economies that are exceptions to the rule like Singapore and Switzerland. But, in general, a larger population generates more overall economic productivity and growth which translates to larger, more valuable companies.

3. Technology

Statistically speaking, the more people we have, the more geniuses and inventors we will find among us. And as the world population has grown, so has the speed of human progress and innovation. Since the start of the Industrial Revolution in 1760, technology has exponentially powered human ability, efficiency, and productivity to new heights.

Today, a child can hold and access the sum of human knowledge in the palm of their hand, something unthinkable just 15 years ago. So long as human spirit and ingenuity continue to strive upward, so will the companies that march to the beat of progress.

4. Natural selection

The final reason why the stock market rises over the long term is because the index always comprises the best companies in the market. For example, to be included in the S&P 500, a U.S. company must have a market cap of US$9.8 billion, and positive earnings in the most recent quarter and year, among other things. If a company fails any of the criteria, the next best company is ready to take its place.

As the pace of technological and economic change speeds up, so will the rate of new, more innovative companies displace old ones. In fact, the average company lifespan on the S&P 500 has fallen steadily over the years.

The five largest companies on the S&P 500 today are Apple, Microsoft, Amazon, Alphabet, and Tesla – companies on the forefront of technology. In 2000, the top five were General Electric, Exxon Mobil, Pfizer, Citigroup, and Cisco. We won’t know what the largest companies will be 20 years from now, but it doesn’t really matter — because they will be included in the index regardless.

Not every stock market around the world rises over the long term. Take for example, Japan. Since its asset bubble collapsed in 1991, Japan entered a period of economic stagnation referred to as the Lost Decade. However, the ‘Lost Decade’ has gone on for 30 years.

Home of the Walkman and Shinkansen (High Speed Rail), Japan hasn’t created a new major innovation since its heyday in the 70s and 80s. In contrast, the U.S. gave rise to the Information Age, which China is now pushing to lead with its fintech and 5G technology. Coupled with an aging population and deflationary environment, Japan’s stock index, the Nikkei 225,has barely grown over the last 30 years, returning a compound annual growth rate of 0.73% from 1991 to 2020.

And as we’ve seen, not every stock market is created equal — stock markets only fundamentally rise when the underlying factors create the right conditions for long-term growth and innovation. So, selecting the right stocks to invest in is key.

So, if indexes always go more up than down, why do so many people lose money in the stock market? First let’s clarify that these high numbers of people losing money refer mostly to day traders who hold on to an individual trade less than a day, often less than an hour. There are long term investors who lose money as well, but these numbers are much lower. The graph at the beginning of this article clearly shows that it’s not the market itself. One reason for failure is bad advice, coming from incompetent and biased sources. Companies themselves (in disguise) or short sellers very often spread false information, trying to move a stock price in their favour. There are financial advisors out there who are not fiduciaries. People trust them with their family finances while their advice is based on what’s in it for them.

The graph makes it look easy, simply invest money and watch it grow. But the graph doesn’t tell the whole story. The down turns look small, insignificant and easy to tolerate but many of them are not. When we expect our money to grow and suddenly, we see it going the other way, emotions come into play. Then very often the media multiplies these emotions.  The latest factor in messing with our emotions has been some of the so-called alternative media, where the public becomes the author. Many people are so fed up with mainstream media that they are subscribing to some of these questionable sources just because they like the narrative. Some of them have political agendas, some of them are long or short in certain stocks or sectors, some of them are selling gold and silver and some of them are trying to make money with comments, likes and shares. Making financial decisions based on these mostly fear inducing, questionable and biased sources is not a good strategy. Almost everyone is now somewhat tied to the financial markets through RSP’s, TFSA’s, RESP’s, Pensions, LIRA’s and so on which makes it very attractive for all kinds of media. Mainstream for ratings, Facebook for likes and shares, YouTube for views and politicians for votes. Be selective with your sources helping you with your financial health. Good financial advice is usually not dramatic at all, quite boring for most.    

Falk Hampel