The Dow Jones Industrial Average closed at a record 14,253.77 on Tuesday.
As we mark the milestone, we should look back and take stock of how far the market—and the companies that drive its trajectory—have come since its last peak in 2007. But we shouldn’t lose sight of how far it has to go—to get to a real record, and to create a sense of shared prosperity.
Market cognoscenti are pooh-poohing the hype. The new record, they note, is artificial because it doesn’t account for inflation. Things get more expensive over time, and a dollar is worth less today than it was six years ago. So 14,254 today isn’t the same as 14,254 in 2007. “In order to reach a new high in inflation-adjusted terms, the DJIA [Dow Jones Industrial Average] would have to rise to 15,397.5, about 8% above its current level,” notes Michael Darda, chief economist and market strategist at MKM Partners.
In addition, critics note that today’s figures are being artificially inflated by the Federal Reserve. The Fed is simultaneously suppressing interest rates and flooding the economy with cash by creating new money to buy Treasury bonds. As a result, investors who buy bonds get next to nothing, and investors who leave their money in the bank actually get nothing. So it’s logical to conclude that stocks are soaring on a sugar high induced by the central bank. Speaking at a luncheon in New York today, David Rosenberg, former economist at Merrill Lynch, now with Toronto-based Gluskin Sheff, noted an 87 percent correlation between the size of the Federal Reserve’s balance sheet and the performance of U.S. stocks. Translation: as long as the Fed keeps buying bonds, investors will (and must) keep buying stocks.
What’s more, the Dow offers an imperfect and oddly constructed view of the market. As I documented in this article 10 years ago (!), the index includes only 30 companies, and excludes utilities and transportation companies. That alone makes it an imperfect gauge of the U.S. economy. What’s more, the index is constructed so that a one-point move in the least valuable company in the index matters as much as a one-point move in the most valuable company in the index. As a result, the Dow doesn’t give us a realistic picture of what’s happening in the market or the economy.
All those points have merit. But there are a few reasons to take heart from the new record. The Standard & Poor’s 500, a broader index that is more reflective of the economy at large and is weighted by market capitalization, also neared a new record high on Tuesday. And while low interest rates are certainly pushing people into stocks, the valuation of the market as a whole is quite reasonable. As Leah Schnurr of Reuters notes, the Dow “sports a price-to-earnings ratio of 14.5 times trailing 12-month earnings,” which is squarely in non-bubble territory and lower than the ratio was at the prior peak in 2007.
In addition, the performance of the Dow (and the S&P 500) does say something real about the U.S. economy. Regular readers will note that I’ve long been pushing back against the notion that the U.S. is in economic decline. A stock market index like the Dow and the S&P 500 may not be the best barometer of national well-being. But it does say something about the ability of U.S.-based companies to thrive in an era when domestic growth is slow and when most of the growth takes place in unfamiliar foreign terrain.
U.S. stocks, it bears repeating, are not a play on what is happening in the U.S. economy. Rather, they’re in large measure a play on what is happening around the world, and on the ability of U.S.-based goods and services to find new audiences, to catch on, to export business models and concepts. And American companies have performed remarkably well in that regard over the last several years. The stock market bottomed out in March 2009. Monthly exports touched bottom in April 2009, and have risen by nearly 50 percent in the past five years, from about $125 billion per month, to nearly $190 billion. According to Standard & Poor’s, for the 252 members of the S&P 500 that broke down sales between U.S. and overseas, the typical company got about 46 percent of revenues outside the U.S. in 2011. The companies in the Dow, which tend to be larger, get an even bigger chunk of sales from outside the U.S. – up to 70 and 80 percent for the likes of McDonald’s, Coca-Cola, Microsoft, and Intel. The Dow is soaring in large part because people around the world like the stuff American companies make. That’s good news.
A second factor holding up profits, though, is not such good news. Profits are high in part because management has been beating the living daylights out of labor in this recovery. While corporate profits have soared in the past four years, salaries haven’t, as Nelson Schwartz noted in The New York Times on Monday. In the third quarter of 2012, corporate profits were 14.2 percent of the total economy—the highest that metric has been in the post-war era—while employees’ chunk of total national income was the lowest it has been since 1966. To put it another way, the U.S. economic pie has been getting larger in recent years. But the share of it devoured by companies and their owners has gotten larger while the pieces left over for workers have gotten smaller.
That’s good for stocks and stockholders, but not so good for the economy as a whole.