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The Dow at a record high…?
Posted at: Mar/07/2013 : Posted by: mel
Related Category: Economics, Perspectives,
Did you hear the news? The Dow Jones Industrial Average (aka the Dow) closed today at a record high of 14,254, easily blowing past the previous record set in October of 2007 at 14,198. After the 2007 peak, the Dow plummeted 54% for the next 18 months, finding a bottom in March of 2009 at 6,547. I would like to say that I feel real good about this news, heck…numbers don’t lie; Unfortunately, sometimes a record isn’t really a record.
I don’t know about the rest of the world, but Americans really love their numbers. Maybe that’s why baseball, football and basketball have been so successful. These sports are very number intensive. I know a lot of people who can in rapid succession fire off what year Babe Ruth hit 60 home runs, how many yards Jim Brown rushed for, the total touch downs thrown by Tom Brady, and total points scored by Magic Johnson. Maybe this is why soccer struggles in America, not enough numbers. Many of the same aforementioned people would struggle when asked what their children’s birthdays are. We put a lot of stock in numbers as a way to measure and compare things.
I have to admit to having the same weakness. Going through school as a youngster I trusted numbers. When asked to solve a math problem, they (the numbers) didn’t lie to me or have some elusive and subjective meaning. If I was fair with the numbers, they always returned truth to me and I could prove it. Reading and writing always seemed so much more mystical. If I had to write about some character or scene in a book, I needed to search for some special motivation, symbolism, or sub-plot. Even once I found the double entendre, I was still at risk of some unforeseen failure. What if I didn’t find what the teacher wanted me to find, or my conclusions did not match the teachers? I always did my math homework last; it was like visiting with a trusted friend after having a conversation with a room full of lawyers all pursuing their own agendas.
Unfortunately, time and age have taught me that even numbers, in the hands of the wrong people can tell a lie….or at least not a whole truth.
Seeing the Dow at more than double its low mark in March of 2009 is good news. As a minimum, this means that investors currently have less fear of the economy and where it is going. People are taking money out of their mattresses and stuffing it into corporate America as equity. The media will run a long ways with this touting it as good news that should lift spirits and raise confidence. Confidence encourages more investing and potentially leads to stronger consumer spending. For all these reasons, today’s stock market report is good news, but it is not a new record.
Despite what is being reported in the news, the Dow Jones Industrial Average did not hit a new high today in any meaningful sense. After adjusting for inflation, the Dow was higher in 2000 than it is today. Coincidentally, it was also higher in 2007. The Dow would need to rise another 1400 points (approximately 10%) to hit an all-time high in real and inflation adjusted terms.
Most other numbers that pertain to economics are adjusted for time and inflation to be meaningful. When people talk about wages having stagnated for American households, it means that, after you adjust for inflation, the median was roughly the same today as it was 15 years ago. I know that 12 years ago I was paying approximately $1.51 a gallon for gasoline, now I pay nearly 3 times as much. If you didn’t adjust for inflation, it would be easy to say that the median American wag has risen by more than 40% in the last 15 years. Anyone challenged to pay their bills on a weekly and monthly basis knows that the notion of a 40% pay increase in the last 15 years for most of us is virtually meaningless.
I know that the Dow, drawn out to two digits right of the decimal at 14,253.77 seems like it must represent something very meaningful and specific with a lot of science behind it, but in reality it is far from it.
What the Dow really is:
A small committee selects 30 big companies that represent a broad cross section of the various sectors of the American economy that are traded on the New York Stock Exchange (NYSE). Currently the Dow includes companies such as I.B.M., G.E., McDonald’s, Disney and a couple of dozen others. The value of each of these stocks at any given time is added up. Then the analysts divide it by the “Dow Divisor”, a misleadingly precise-seeming number formulated to account for things like dividends and splits, price to earnings ratio, etc. Right now the Dow Divisor is at about 0.132129493 which sure looks official. I remember in science classes dealing with a lot of equally impressive numbers that were considered coefficients or constants; those numbers seemed important and worthy of respect and potentially memorization. Incorporating the Dow Divisor in the equation as a coefficient, the resulting figure is called the Dow and reported across the country and the globe. Unlike a coefficient or constant in science, the Dow Divisor periodically changes.
If you aren’t confused by the Dow yet, let me push you further in that direction and finish the process. More troubling to me is that the Dow ignores overall corporate size and value with a myopic share-by-share view of its 30 member stocks. Because the Dow looks at the individual share, rather than the overall corporate view, some imbalances are easily manifested. ExxonMobil, for example, divides its value into nearly five billion lower-cost shares, while Caterpillar has around 650 million more expensive shares. Therefore ExxonMobil, one of the largest companies in history (and currently very successful), pulls less weight on the Dow Jones Industrial Average than a company less than a fifth its size and total corporate value.
If you are really into monitoring the stock market, there are other, less arbitrary indexes of the U.S. markets, such as the S&P 500, which tracks 500 (rather than just 30) big U.S. companies. The S&P 500, for what it's worth, is below its all-time highs in both nominal and inflation-adjusted terms.
The Dow isn't really at a record high; I believe economic things would likely seem a lot different if it were. Our media overwhelms us with the terms “Wall Street” and “Main Street.” Wall Street is the metaphor for the special place where equity in American businesses is bought, sold and traded. For most of us, this is a meaningless place occupied by movie characters and high-rollers that periodically get caught with their hand in the cookie jar. Main Street is where the rest of us live deciding whether we can safely get another 2 months use out of the tires on our car.
I respect the fact that Wall Street is an important part of our economy; it is where investment begins. It is good to see that the Dow has recovered some of its lost value over the last few years. Putting money into the equity of business is a sign of investor confidence. Nevertheless, the math is still more marketing and mysticism than straight forward fact. I haven’t totally lost my faith in numbers, but until Main Street begins to rebound like Wall Street, the Dow is just a media number driven by some continuously changing coefficient. I haven’t tried it yet, but I don’t believe there is a way for me to pay my bills on Main Street with coefficients.