Next stop, 15,000? As the Dow Jones Industrial Average settled at a new all-time high of 14,253.77 on March 5, the psychological lift on Wall Street was undeniable — the market was finally back to where it was in 2007. Or was it? 1
For many, the Dow “is” the stock market, and the stock market, in turn, is a direct product of the economy. Of course, it does not always quite work that way. Right now, it is worth examining some of the factors that have driven the Dow to its series of record closes. Question is; does the Dow’s impressive winter rally signal anything more than unbridled bullish enthusiasm? Here are a few thoughts on that:
The small picture. Investors should remember that the Dow Jones Industrial Average includes just 30 stocks – 30 closely watched stocks, to be sure, but still just 30 of roughly 2,800 companies listed on the New York Stock Exchange. On the other hand, the S&P 500, with its 500 components, is considered a better measure of the market. When you hear or read that “stocks advanced today” or “stocks retreated this afternoon,” understand that this reference more accurately reflects activity with the S&P.
You could argue that the Dow is even less representative of the broad stock market than it once was. In 2007, Kraft, Citigroup and General Motors were among the blue chips; since then, they’ve been tossed out and the index has gotten a little more tech-heavy.
If you add up all the share prices of the 30 stocks in the Dow, you will not get a number over $14,000. The value of the Dow = 7.68 times the total share prices of all 30 Dow components. How did Dow Jones arrive at the magic multiplier of 7.68? It is a direct reflection of what’s called the Dow Divisor, which is a numerical value computed and periodically adjusted by Dow Jones Indexes. That being for every $1 that shares of a DJIA component rise in price, the value of the Dow rises 7.68 (and the Dow Divisor currently is well beneath 1 – on March 7 it was 0.130216081).
It is noteworthy to know the DJIA isn’t indexed to inflation, so hitting 14,167 in 2013 isn’t quite like hitting 14,167 in 2007. It is a price-weighted index as well (i.e., each Dow component represents a fraction of the index proportional to its price), which also makes comparisons between 2007 and 2013 a bit blurry.
The big picture: The Dow surpassed its old record thanks to many factors — an improving housing market, stronger activity in the manufacturing and service sectors, an encouraging employment report and of course earnings. Perhaps the most influential factor, however, is central bank policy. The Federal Reserve’s ongoing bond-buying has stimulated the real estate industry, the market and the overall economy, and fueled the DJIA’s ascent.
In the big picture, there are two perceptions that are moving the market higher: One is the belief that the recession is over. The other is the assumption that the Fed will keep easing for a year or more. Pair those thoughts together, and you have grounds for a more optimistic outlook as we have today.
Any time the Dow flirts with or reaches a new record high, bears come out and caution that a pullback is next. Though many analysts feel stocks are fairly valued at the moment, a combination of headlines could inspire a retreat — but not necessarily a correction, or a replay of the last bear market.
And while the market soared in the first quarter, don’t forget that the economy grew by just 0.1 percent in the fourth quarter by the federal government’s most recent estimate.
Going forward, if the Dow hits 14,500 or 15,000, this won’t confirm that the economy has fully healed or that the current bull market will last “X” number of years longer. It will be good for Wall Street’s morale, however, and that’s usually healthy for the rest of us here on Main Street, as well.
Finally, it’s always good medicine to remember Will Roger’s most famous quote as to investing when he said: “The best way to double your money is to fold it in half and button it up in your back pocket.”
Ike S. Trotter, CLU, ChFC, is a financial advisor in Greenville. Securities and investment advisory services provided through Woodbury Financial Services Inc., Member: FINRA, SIPC and Registered Investment Advisor, P.O. Box 64284, St. Paul, MN 55164. Tel: 800.800-2638. IKE TROTTER AGENCY, LLC, and Woodbury Financial Services are not affiliated entities. Information and opinions expressed are those of the author and not necessarily those of Woodbury Financial Services Inc.