The S&P 500’s long-term performance is obvious. It keeps going up. The S&P 500 has grown by a staggering 22,190% from 1950 to 2020 ( 212.524.72% with dividends reinvested! The market continues to rise despite all kinds of crises including pandemics and world wars.

This pattern is not only true in the U.S.

This pattern is not only true in the U.S. but also in other major economies such as China, Germany and India. Stock markets tend to rise over the long-term. Why is this?

Before we get into the reasons, let’s first define the stock market. The stock index is usually used to report that the stock market rose by 2% today. A stock index is basically a collection of stocks that attempts to reflect the entire stock market or a subset thereof.

The S&P 500, for example, is a collection of 500 stocks in the United States from different sectors, such as IT, healthcare, financials and consumer discretionary. It also includes communication services, industrials and consumer staples, energy, utilities and real estate. The market cap weight of the index determines how large companies make up the S&P 500. 28% are the top 10 largest companies, accounting for about 25% of the S&P500’s weight.

1. Inflation

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 profit over time (all things equal). And when companies increase their revenue and profit, their stock value grows in tandem. 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, the above 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. On the other hand, runaway inflation as seen in Venezuela and Zimbabwe will sow uncertainty and stifle economic growth, and push investors to look elsewhere for opportunities.

2. Population growth

The world has 7.8 billion inhabitants as of January 2021. This number is expected to rise before reaching 11 billion in 2100. Companies are more likely to be able to reach a wider market if there is a higher population. Companies that are able to sell to a growing, larger market over time become more valuable.

A greater population can support more skilled workers and industries. A small, developing economy with one million inhabitants may only have industries in manufacturing, agriculture, and raw materials. A larger and more sophisticated economy with 100 million people can have specialized industries in technology, communications finance, retailing, entertainment, tourist, professional services, and other areas.

There are, however, exceptions to this rule such as Singapore and Switzerland. However, the general rule is that a larger population leads to greater economic productivity and growth, which in turn leads to more valuable businesses.

productivity and growth which translates to larger, more valuable companies.

3. Technology

Statistics show that the greater the number of people, the more inventors and geniuses will be among them. As the world’s population has increased, so too has human progress and innovation. Technology has risen exponentially in human productivity, efficiency, and capability since the Industrial Revolution began in 1760.

With the invention of the steam engine, factories and mills were able to be found anywhere. The railroad was also created, which opened new frontiers. Humans could now work late into the night thanks to the lightbulb. The microprocessor was a meta invention that enabled thousands of new technologies to be invented, including the personal computer and the Internet.

Today, children can access and hold the entire human knowledge within their hands. This feat was impossible 15 years ago. Companies that continue to march to the beat will be able to keep up with human spirit and ingenuity as long as they are driven by innovation.

productivity and growth which translates to larger, more valuable companies.

4. Natural selection

The last reason the stock index has a long-term rise is that it always includes the best companies on the market. To be included on the S&P 500, an American company must have a market capital of US$9.8billion and positive earnings for the most recent quarter or year. The next-best company will replace it if the company fails to meet any criteria.

The pace of technological and economic changes is increasing, and so will the rate at which newer, more innovative companies replace old ones. The average S&P 500 company lifespan has been decreasing steadily over the years.

Apple, Microsoft and Alphabet are the five biggest companies in the S&P 500. These companies are at the forefront of technology. The top five companies on the S&P 500 in 2000 were Exxon Mobil (General Electric), Citigroup, Pfizer and Citigroup. Although we won’t be able to predict where the biggest companies will be in 20 years, it doesn’t really matter because they will be included on the index regardless.

Are all stock markets on the rise?

Over the long-term, not all stock markets around the globe rise. Japan is an example. Japan fell into economic depression in 1991 after its asset bubble burst. The ‘Lost Decade” has continued for over 30 years.

Japan, the birthplace of the Walkman or Shinkansen, has not created any major innovations since the 1970s and 1980s. The Information Age was created by the United States, and China is now leading the charge with its 5G and fintech technology. The combination of an aging population, deflationary environments, and Japan’s stock market, the Nikkei225, has seen Japan’s stock index shrink over the past 30 years. It returned a CAGR (CAGR) of 0.73% between 1991 and 2020.

The fifth perspective

An exchange traded fund that tracks the stock market index is a good long-term investment strategy. The SPDR S&P500 ETF has provided investors an annualized return of 10.04% since its inception in 1993. This strategy is only applicable to the stock market overall, as individual companies are not guaranteed success.

As we have seen, not all stock markets are created equal. Stock markets only fundamentally grow when the underlying factors provide the right conditions for innovation and long-term growth. It is important to choose the right stock market index for you to invest in.

The most competitive stock markets will continue to grow and thrive. The future is bright if you believe in human endeavour and imagination.

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