What if they held a bull market and no one came?: James Saft
(Reuters) - The remarkable thing about the Dow Jones Industrial Average's new all-time record is how few people give a damn.
There are good reasons for this - the Dow is the doddering uncle of stock market indicators and it, along with the rest of the stock market, is being held aloft by the magic fingers of Federal Reserve policy.
More importantly, there are important consequences of the record's lack of consequence: with no feel-good factor people won't be piling into stocks like the lemmings they usually are, nor will they be as likely to go out and spend the (paper) gains.
The Dow rose again on Wednesday, setting a record for the second day running by rising to 14,320. The Dow's last record run ended in October 2007.
First off, the Dow Jones Industrial Average is one of those things about which you can justifiably use the words venerable and stupid in the same sentence.
Though it has age on its side - it has been around almost 117 years - it is fiendishly narrow, comprising only 30 stocks, and thus is a really poor barometer of not only the broader economy but of that portion of it which you can access through equity markets. It is also - and this is flabbergastingly wrong - a price-weighted average, meaning that it is calculated not by the market capitalization of its components but by their share prices. That gives stocks with "high" nominal prices - like IBM - more importance than those with "low" prices like Bank of America. Why we should care more about IBM going to 233 from 231, an advance of 1 percent, than Bank of America going from 11 to 12, a gain of 9 percent, I could not tell you.
Still, the index is at all-time nominal highs and has actually done better than that if looked at properly. On a total return basis, taking into account dividends as well as share price moves, it is now about 17 percent above its previous peak. If you slice off the 11 percent in inflation we've had since October 2007 you are still ahead.
EPHEMERAL GAINS? WHAT EPHEMERAL GAINS?
The broad Vanguard Total Bond Market ETF is up by nearly 25 percent on a total return basis over the same period and if you could have got access to a fund paying a 30-day LIBOR rate you would have outperformed as well. And all of this is before we take into account the very extreme volatility of equities during the crisis and its aftermath.
Volatility is supposed to pay, as it most surely does cost, but on the evidence the rewards for taking stock market volatility have been slim indeed if all you get for five and a half years is an extra 6 percent above inflation. That is a lot of risk and a very slim premium.
So on that basis it is not surprising that investors are not all that ginned up by our new all-time high.
Add to this the widespread suspicion that extraordinary monetary policy is artificially inflating stock market prices and you have a recipe for skepticism. I say suspicion, but that is probably not strong enough. Ben Bernanke and other Fed officials have been forthright about the fact that it is their intention, through quantitative easing, to drive funds into riskier markets, thereby making the owners of equities feel richer and be more likely to spend and invest.
Of course if you tell people you are inflating something artificially they are going to behave as if it is, well, artificial.
Neal Soss, an economist at Credit Suisse, has done interesting research indicating that the wealth effect isn't as strong any more for equities or for housing.
"Wealth effects appear to have shrunk since the 2007-2008 financial crisis, and more so for housing wealth than for stock market wealth," Soss wrote in a note to clients.
"One implication of this result is that the Federal Reserve will need to 'engineer' even larger bull markets in house prices and stock prices for any given desired pick-up in economic growth. The great financial crisis is proving to have a long tail."
This makes perfect sense. If there is anything households have learned in the past decade it is that paper gains are just that, and not to be relied upon.
The question you have to ask yourself is: given that its policy doesn't really work, is the Fed going to pump up asset prices even more or will they stop?
Perhaps this time they will do the same thing over and over again and get a different result.
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)