What if they held a bull market and no one came?: James Saft
March 6 (Reuters) – The remarkable thing about the Dow Jones
Industrial Average’s new all-time record is how few people give
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)
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,
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
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 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. You can email him
at email@example.com and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)