Equity market cheerleaders got very excited about the Dow Jones Industrial Average hitting a new record high yesterday (Tuesday).
The Dow closed at 14,253.77, topping its previous record close of 14,164.53 on Oct. 9, 2007.
While it is nice to see a sign that equities are improving following the devastating shock of the financial crisis of 2008, today’s Dow Jones Industrial Average is not the same index as it was in 2007.
In fact, if we look back at when the Dow Jones Industrial Average last exceeded 14,000, we’ll see that the Dow seems to have less of a connection now to what is really happening in the economy than it did in 2007.
When the Dow Hits Record High, What Does It Mean?
In October 2007, the equity market was completing a spectacular rally that began in the spring of 2003.
Share prices had been correcting after the Tech Rally of 1999-2000, and the terrorist attacks of Sept. 11, 2001 accelerated their decline.
During the second half of 2002, the Dow Jones Industrials formed an inverted head-and-shoulders pattern, which completed the correction.
By the time the Dow Jones Industrials confirmed the reversal in June 2003, the Fed had been aggressively pumping money into the economy for nearly two years. The Fed’s expansionary policies provided the monetary fuel that drove the Dow Jones Industrials up by nearly 54%, from 9,100 in June 2003 to over 14,000 by October 2007.
The U.S. economy in 2007 was a very different picture than today.
GDP growth was 2.5% compared with only 1.6% now.
There were 6.7 million people unemployed in 2007 vs. 13.2 million unemployed today.
Labor force participation was 65.8% in 2007 but is only 63.6% now as Baby Boomers have started to retire and workers in their 50s and early 60s have dropped out of the labor force because they are unable to find work.
Consumer confidence was 99.5 in October 2007. It is only 69.6 today.
Although the Fed was being aggressively accommodative in 2007, the size of its balance sheet was only $890 billion compared with $3.01 trillion today.
In 2007, total U.S. government debt outstanding was $9 trillion. Today it stands at $16 trillion.
U.S. 10-year Treasury bonds yielded 4.64% in 2007. Now, 10-year Treasuries yield only 1.89%.
In 2007, spot gold was $748. Today gold is priced at $1,583.
Despite the fact that the Dow Jones Industrials have risen about the same amount from the July 2009 breakout from the inverted head-and-shoulders pattern that signaled the bottom of the 2008-2009 financial crisis, this has not translated into improved consumer confidence or robust economic activity.
What the Dow’s New High Says About the Market
What does the new high in the Dow Jones Industrial Average tell us about the market as a whole?
In a couple of words, not much.
Let’s look at the index for what it really is. Although it is widely followed, the Dow Jones Industrial Average is made up of only 30 companies out of the more than 3,000 listed companies in the United States. As such, it is not really representative of the U.S. economy as a whole.
The index is not weighted by market capitalization but rather by price. That means the highest-priced shares have the most influence on the calculation of the index.
The companies that make up the Dow Jones Industrial Average have changed considerably since the old high in October 2007.
Five of the 30 companies that were in the index in October 2007 – Altria Group Inc. (NYSE:MO), Honeywell International Inc. (NYSE: HON), American International Group Inc. (NYSE:AIG), Citigroup Inc. (NYSE: C) and General Motors Co. (NYSE: GM) – have been replaced. AIG, Citi and GM all received government bailouts in the wake of the financial crisis.
Added to the Dow were Bank of America Corp. (NYSE: BAC), Chevron Corp. (NYSE: CVX), UnitedHealth Group Inc. (NYSE: UNH), Cisco Systems Inc. (Nasdaq: CSCO) and Travelers Companies Inc. (NYSE: TRV). (AIG was replaced by Kraft Foods in September 2008, and Kraft was replaced by UnitedHealth Group last year.)
Bottom line: The Dow Jones Industrials in 2013 tell us little about the state of the overall equity market – and even less about the state of the economy.
All of the hoopla over the Dow’s record high is just a lot of noise.
By Jeff Uscher, Contributing Writer, Money Morning– March 6, 2013