Dow Jones Closes at Record High

When the trading day ended on
Tuesday, the Dow Jones Industrial
Average closed at a record high of
14,253.77. It surpassed the index’s
previous closing high of 14,164.53
reached back in the pre- recession
days of October 2007. For all the
headlines devoted to the event, you’d
think this was a really big deal —
either a signal that our economy has
zoomed past the lingering aftereffects
of the Great Recession, or evidence of
a bubble about to pop, as CNBC
wondered a little while ago.
The reality is probably much less
exciting. “Investors should curb their
enthusiasm,” says Mitchell O.
Goldberg, president of ClientFirst
Strategy. Experts say the Dow’s
record high means relatively little in
the grand scheme of things. Here are
a few reasons why:
The Dow Doesn’t Reflect the Entire
Economy
“To the average guy in the public, the
Dow means the market,” says Wayne
S. Kaufman, chief market analyst at
John Thomas Financial. “But it’s only
30 stocks.” What’s more, the index is
price-weighted, meaning more
expensive stocks have an outsized
impact on the number.
The 30 stocks that currently
constitute the Dow Jones Industrial
Average make up a pretty narrow
slice of American economic output.
Analysts say the S&P 500, a much
bigger index, is more reflective of the
market as a whole. (It ended Tuesday
at a five-year high, but fell short of
record-breaking status.)
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Also, the companies included in the
Dow have changed over the years,
and inflation is not factored in, so
measuring today’s record against its
previous high is an apples-to-oranges
comparison. “When you see the Dow
hitting new highs, it’s not the same
Dow we had in ’07,” Goldberg says. He
points out that manufacturing
stalwart General Motors was booted
out, as were Citigroup and Kraft, and
he argues the current index skews
too tech-heavy to encompass the true
scope of the U.S. economy.
The Fed Did This — and It Can Undo
It Too
Stocks have been particularly
buoyant because they’re floating on
an ocean of liquidity, courtesy of the
Federal Reserve. The Fed has been
buying up trillions of dollars of bonds
to stimulate the economy. That has
driven down yields and interest rates.
“Back in 2007, bond yields were 5%
on a 10-year [government] bond,”
Kaufman says.  ”Today, we’re at
1.9%.” As a result, many investors
who are looking for better returns
have given up on bonds and piled into
the equities market, since many are
still soured on real estate as an
investment vehicle.
“So long as the Fed is in an
accommodative mode and the
economy is out of recession, the odds
are that you will have a bull
market,” David Rosenberg, chief
economist at Gluskin Sheff and
Associates, told the New York Times
Tuesday.
“The Fed seems willing to remain
accommodative,” says Matthew
Coffina, editor of Morningstar’s
StockInvestor subscription
newsletter. Plus, he adds, stocks are
considered to be a better hedge
against inflation when the economy
does pick up steam again.
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In addition to the Fed, central banks
around the world have engaged in
“globally synchronized asset purchase
programs,” Kaufman said, which
pumps more money into the system.
Other Numbers Matter More
Morningstar’s number-crunchers
take the price of each stock they
cover, divide it by what their analysts
think it’s worth, rank all of them and
take the median. (You can see the
current ratio in this chart here.)
Lately, it’s been pretty close to zero,
which indicates a more or less fair
value for the market in aggregate.
“The thing to focus on is price to fair
value ratio,” Morningstar’s Coffina
says. “Right now, our analysts think
the market is right about fairly
valued.”
The robust balance sheets of
corporations help justify high stock
prices. “I think the main positives for
the market have been relatively
strong corporate earnings,” Coffina
explains. “Companies have been able
to take advantage of high
productivity.”
Even so, high stock prices don’t
necessarily signify a strong economy.
“I think the market may be feeling
more strength than the consumer is
feeling,” Coffina says.
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There are several other key data
points to consider. “The most
important metric people should be
looking at is employment, bar none,”
Goldberg says. “The second figure
everybody has to look at is inflation.
The third figure is bank lending.”
Following that advice gives you a
much more mixed bag concerning the
overall health of the economy:
Unemployment is stubbornly high,
inflation isn’t really an issue, and
bank lending looks encouraging.
We’re Not Out of the Woods Yet
Whether or not the market will
continue its upward march is
anybody’s guess. People get paid
huge amounts of money to figure it
out, and they still get it wrong more
often than not. Analysts like to point
out that it’s foolish to try to time the
market right, and that there are still
plenty of risks that could topple the
market’s ascent.
“You have to trust [Federal Reserve
chairman Ben] Bernanke and
company to thread the needle and
pull back on their easing policies
without disrupting the domestic
economy,” Goldberg says.
As Warren Buffet pointed out on
CNBC on Monday, the economy could
be rattled when this happens. ”There
are an awful lot of people who want
to get out of a lot of assets if they
think the Fed is going to tighten a lot,”
he said. Even if the Fed chairman can
get everything right, lawmakers could
still make a mess of things, between
dickering over sequester cuts and the
looming budget showdown coming at
the end of the month, analysts say.
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Trouble could come from overseas,
too. Goldberg says bold moves by the
European Central Bank have
mitigated the threat of a cascade of
major bank failures, but an anemic
Eurozone economy would be bad
news for American export-driven
companies.
“Although Europe is not nearly as
significant a trading partner for the
U.S. as it used to be, it still is a
massive part of the developed world,”
he says. “If consumers and businesses
cut back, it hurts.