I read this on a forbes article.

From September 1967 to September 2007, the S&P 500 produced an 
annualized return of 7.14%, compared to the annualized gain of 4.67% in 
the CPI over the same period.

I don't understand this. The S&P is a benchmark of the value of the top american companies. So why doesn't it track with inflation? All I can conclude from this is that over the last 40 years, american money has moved away from milk and bread and moved into the stock market. But surely this is wrong because it is stock market companies that make the milk and bread that we buy!

  • 7
    You don't expect the top companies to outperform inflation? It'd be concerning if they didn't.
    – Hart CO
    Jun 25, 2017 at 15:23
  • @HartCO But if this continues, every US dollar will be in the S&P
    – user56973
    Jun 25, 2017 at 15:32
  • 5
    The S&P 500 isn't a static list of companies, companies come and go from the index, so not all money is moving to the S&P500, the top 'n' of anything by definition are outperforming others, but it doesn't mean they always will be. If the list was static, your expectation of it aligning more closely with inflation would be more reasonable, except that publicly traded companies aren't the full picture, you'd need a representative mix that included private companies to get a clear picture.
    – Hart CO
    Jun 25, 2017 at 15:46
  • 7
    "But if this continues, every US dollar will be in the S&P." It sounds like you have confused inflation with growth in the money supply. You can have zero inflation and still have a lot of growth in the money supply and that growth can continue forever. Generally speaking, our money supply grows faster than inflation over long horizons.
    – farnsy
    Jun 26, 2017 at 4:20

3 Answers 3


TL;DR: Because stocks represent added value from corporate profits, and not the price the goods themselves are sold at.

This is actually a very complicated subject. But here's the simplest answer I can come up with. Stocks are a commodity, just like milk, eggs, and bread. The government only tracks certain commodities (consumables) as part of the Consumer Price Index (CPI). These are generally commodities that the typical person will consume on a daily or weekly basis, or need to survive (food, rent, etc.). These are present values.

Stock prices, on the other hand, represent an educated guess (or bet) on a company's future performance. If Apple has historically performed well, and analysts expect it to continue to perform, then investors will pay more for a stock that they feel will continue pay good dividends in the future. Compound this with the fact that there is usually limited a supply of stock for a particular company (unless they issue more stock).

If we go back to Apple as an example, they can raise their price they charge on an iPhone from $400 to $450 over the course of say a couple years. Some of this may be due to higher wage costs, but efficiencies in the marketplace actually tend to drive down costs to produce goods, so they will probably actually turn a higher profit by raising their price, even if they have to pay higher wages (or possibly even if they don't raise their price!). This, in economics, is termed value added.

Finally, @Hart is absolutely correct in his comment about the stocks in the S&P 500 not being static. Additionally, the S&P 500 is a hand picked set of "winners", if you will. These are not run-of-the-mill penny stocks for companies that will be out of business in a week. These are companies that Standard & Poor's Financial Services LLC thinks will perform well.


Inflation and stock returns are completely different things

The CPI tracks the changes in the prices of a basket of goods a consumer might buy, the S&P 500 tracks the returns earned by investors in the equity of large companies. The two are very different things, and not closely linked.

Example: A world without inflation

Consider a world in which there was no inflation. Prices are fixed. Should stocks return zero? Certainly not. Companies take raw materials and produce goods and services that have value greater than that of the raw materials. They create new wealth. This wealth becomes profit for the company, which then is passed on to the owners of the company (equityholders) either in the form of dividends or, more commonly, price increases.

Example: A world with no inflation and no economic growth

Note that I have not implied above that companies have to grow in order for returns to outperform inflation. Total stock returns depend on the current and expected profit of the firm. Firms can remain the same size and continually kick out profits. Total returns will be positive in this environment even if there is no growth and no inflation. If the firms pay the money out as dividends, investors get a cash flow. If they retain these earnings, the value of the firm's equity increases. Total returns take both types of income into account. Technically the S&P 500 is not a total return index, but in our current legal and corporate culture environment, there is a preference for retaining profits rather than paying them out. This causes price increases.

Risk bearing

In principle, if profit was assured, then investors would bid up stock prices so high that profit would have to compete with the risk-free rate, which often is close to inflation (like, right now). However, profit is not assured. Firm profit swings around over time and constitutes a significant source of risk. We can think of the owners of the firm as being the bondholders and equityholders. These assets are structured such that almost all the profit risk is born by equityholders. We can therefore think of equityholders as being compensated for bearing the risk that would otherwise be born by bondholders. Because equityholders are bearing risk, stock prices must be low enough that stocks have a positive expected return (above the risk-free rate, which is presumably not significantly below inflation). This is true for the same reason that insurance premiums are positive--people have to be compensated for bearing risk.

See my answer to this question for a discussion of why risk means we should expect stock prices to increase indefinitely (even if inflation halts).

The S&P is not a measure of firm size or value

The S&P measures the return earned by investors, not the size of US companies. True, if constituent companies grow and nothing else changes, the index goes up, but if a company shrinks a lot, it gets dropped out, rather than dragging the index down.

By the way, please note that dollars "put into" equities are not stuck somewhere. They are passed on to the seller, who then uses it to buy something (even if this is a new equity issuance and the seller is the firm itself). The logic that growth of firms somehow sucks money out of usage is incorrect.

  • I was applauding your excellent explanation up to the part about risk-bearing. If a company was 100% risk free, yes, I'd certainly expect the share price to be bid up. But I don't see why it would it stabilize at a price that gives a net return after inflation of zero. If that was true, then if you had a large basket of stocks, like a mutual fund, where there are always some percentage of companies going bankrupt and their value falling to zero, the net total return on the basket should be zero. And that's clearly not true.
    – Jay
    Jun 27, 2017 at 15:53
  • By definition, 100% risk-free companies can't go bankrupt. If they paid out a fixed and known amount forever with certainty, then the stock would be just like a bond. Not just any bond either, it would be like a risk-free bond (think short-term treasuries). As you know, treasury bonds yield very little. Returns are about both the payments being made and the price you have to pay in order to get those returns. If the price is very high, your returns will be low. The only way to get high expected returns is if the price is low relative to expected payments, which happens because of risk.
    – farnsy
    Jun 27, 2017 at 15:59
  • @famsy Well, don't want to get into a debate. I certainly agree that lower risk means a lower return. What I challenge is your assertion that the return will be net zero after inflation.
    – Jay
    Jun 27, 2017 at 16:12
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    @Jay Ahh I see. Stock returns that have no risk at all should earn the risk-free rate. Whether this risk-free rate exceeds the inflation rate is only an empirical, historical, observation, not part of the theory I have shared. The rate would depend on the demand for borrowed funds and availability of competing investments.
    – farnsy
    Jun 29, 2017 at 14:47
  • Yes, exactly. I think we're in agreement.
    – Jay
    Jun 29, 2017 at 16:14

The U.S. economy has grown at just under 3% a year after inflation over the past 50 years. (Some of this occurred to "private" companies that are not listed on the stock market, or before they were listed.)

The stock market returns averaged 7.14% a year, "gross," but when you subtract the 4.67% inflation, the "net" number is 2.47% a year. That gain corresponds closely to the "just under 3% a year" GDP growth during that time.

  • I think the point of the question was an assumption that economic growth (measured by the stock market) and inflation are the same, when in reality they are different concepts.
    – D Stanley
    Jun 29, 2017 at 18:57
  • @DStanley: That's why I tried to break down the "gross" 7.14% number into its two parts.
    – Tom Au
    Jun 29, 2017 at 18:59

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