With the Nasdaq recently closing above 5,000 for the first time in a decade-and-a-half, bears have said that the index really should be adjusted for inflation to get a better assessment of where things stand, valuation-wise. Barry Ritholtz says that’s nonsense.
In his Bloomberg View column, Ritholtz cites three reasons why insistence that all data be adjusted for inflation is “the last refuge of scoundrels”. The most important of those reasons, Ritholtz says, may be one involving the mathematics behind equity valuations. “To determine an inflation-adjusted valuation, you would have to discount both the price AND the earnings (or whatever other element that is your preferred basis of fundamental measure) for the inflation rate,” he says. “Multiplying the top and bottom of a fraction by the same number doesn’t alter the ratio. Thanks for a whole lot of nothing.”
Ritholtz says inflation is indeed a meaningful issue, calling it “a pernicious threat to holders of any asset — cash, stocks, commodities, real estate and especially bonds.” He explains why stocks tend to be a good inflation hedge compared to those other options. The point of business and investing, he says, is to “expand a business faster than the rate of inflation. When earnings AND stock prices both rise together, adjusting for inflation tells us precisely zero about valuations.”