Another video by Paul Solman in which he discusses how the NYSE record high doesn’t reflect the fundamentals of the US economy. With interest rates at virtually 0% the US Federal Reserve is trying to lower unemployment by stimulating the economy. But, by doing so there has been a tendency for it to overstimulating the stock market in the process. And also lending to stock investors, whose margin debt to buy shares on credit has been hitting record highs. Last week the Dow ended above 16000, another record for the headline index of 30 major companies.
The last record was set in 2007, a few months before the Dow’s previous high watermark.But for all the talk of the Fed’s role there’s an alternative way to understand a record Dow and higher profits: a shift of power from workers to owners. The stock market would actually be much higher if the unemployment was much lower. I think the economy is still really fundamentally weak, and that slack that’s in the economy right now, with all the unemployed people, all the unemployed businesses, would actually bring up the stock market even further.
Here is yet another graphic from The Economist showing the change in stock markets since the peak before the financial crisis in 2007/8. Although Dow Jones Industrial Average surpassed its previous peak (though it is still around 7% off once inflation is taken into account) – see previous post. As you can see some stockmarkets are still struggling and Greece is more than 80% below its peak in 2007.
The media last week were championing the fact that America most-cited benchmark, the Dow Jones Industrial Average (consists of the biggest 30 companies on Wall Street), had surpassed the peak that it reached prior to the Global Financial Crisis in 2008. Although the DJIA has doubled since March 2009 the American economy has only grown over the same period by 7% in real terms. Ultimately there is no real correlation between GDP growth and stock market returns The Economist stated main reason for this is that central banks worldwide have been forcing down the returns on Government bonds hoping to get investors to put money into more risky assets and therefore restore confidence amongst businesses and consumers.
Do the figures stack up?
Although the DIJA has hit a record high numerically, has inflation been factored into the calculation? If you look at the real figures (adjusted for inflation) the Dow Jones is approximately 9% below where it was in October 2007. Therefore the purchasing power of your shares in October 2007 is greater than that of today.
In real terms DIJA would be around 12,900 instead of the peak of 14,253.77 on Tuesday 5th March.
Justin Lahart in the Wall Street Journal stated last week that when you included the dividends earned (with investments in the DIJA) over the past five and half years and if they were reinvested the DIJA would be at 16,000. Adjusting for both inflation and dividends would put the DIJA around 15,000 – up approximately 5%.
Another consideration that he alluded to was that the DIJA doesn’t really reflect how well the average stock is doing. Companies with high market capitalisations like Apple are worth more than others also stocks like International Business Machines are worth more than others. Therefore stocks with the largest weightings have tended to weigh on the DIJA. If you put all stocks on the same footing since DIJA’s old record, and the index would have performed much better. The equal-weighted DIJA now stands at 16,683.44 which is 2,518.91 points higher than its 2007 high of 14,164.53 – see graph below.