From time to time I get emails asking for a nominal version of one of my inflation-adjusted charts of the S&P Composite. I usually reply that a nominal chart over many decades with dramatic changes in inflation simply wouldn't make any sense, much less be useful.
This morning's email brought a request from an investment professional in Montréal for a nominal version of my monthly market valuation update featuring the S&P Composite and the P/E10, the top chart.
Well, if a picture is worth a thousand words, here's my 1000-word essay on why I adjust for inflation. And I'm tossing in a bonus 1000 words on why I use a logarithmic scale for the vertical axis (another common question I'm asked).
The top chart is real, which means it's adjusted for inflation. The vertical axis is on a logarithmic scale, which means that a 100% gain from a price of 115 (say 1980 to 1986) will have the same vertical move as a 100% increase when the market is at 1150 (don't we wish!).
The second chart is nominal. This means, for example, that the stunning inflation during the 70s and early 80s (at times in double digits) disguises losses and gives the illusion of gains. And the horrible deflation of the Great Depression makes the chart look even worse.
The third chart, also nominal, uses a linear vertical axis scale. It gives the illusion that the market was flat for 80 years, and then sometime after WWII, it accelerated into an incredible pair of bubbles. Well, maybe there is a tiny bit of truth in this goofy chart.
