The Dow Jones industrial average hit a new record high on Tuesday, and you’re not in a celebratory mood? Don't fret, you’re not alone. And the widespread skepticism is based on some real concerns. Here are five of them.
1. Getting excited about the Dow’s new record is like cheering for an athlete everyone knows is using performance enhancing drugs. In the case of the Dow, and the stock market in general, some of the gains have been driven by aggressive stimulus policies of the Federal Reserve – including ultra-low interest rates and, most recently, open-ended asset purchases designed to hold down borrowing costs and encourage risk-taking in the stock market. It worked, but what happens when the Fed withdraws the stimulus?
2. There is a puzzling disconnect between the stock market and the economy. Look for confirmation of the bull market in recent economic data and you won’t find much. The U.S. economy grew – if you can call it that – just 0.1 per cent in the fourth quarter. Sure, U.S. companies do a lot of business overseas, but Europe is stuck in recession and even China is stumbling. In his final speech as China’s premier, Wen Jiabao issued a growth target of 7.5 per cent. That’s low by China’s standards, and the target also came with a caveat: It won’t be easy to reach this year.
3. Record-high index means record-high stock prices – but that doesn’t stop some pundits from talking about how cheap stocks are. Of course, they are referring to share prices relative to earnings, which do look reasonable. But other, more persuasive, measures look expensive. For example, take Robert Shiller’s cyclically adjusted approach and compare share prices to rolling 10-year inflation adjusted earnings and you’ll find that stocks trade at about 23-times earnings. Pricey!
4. If stocks are so great, why is no one buying them? Okay, investors showed a lot of interest in equity mutual funds in January – but the longer-term trends have reflected widespread dissatisfaction with stocks: According to Lipper, outflows from U.S. mutual funds and exchange traded funds have totalled more than $150-billion (U.S.) from 2008 through 2012. Investors have preferred the safety of bonds and cash throughout this period, wary of bear market crashes and market shenanigans. Meanwhile, trading volumes have fallen sharply. At the New York Stock Exchange, trading volumes fell nearly 27 per cent in 2012.
5. Dow schmow. The Dow is an interesting index, an old index and a headline-grabbing index. But it is not the index. It tracks just 30 stocks and weights them according to share price rather than market capitalization – making it a distorted reflection of the U.S. equity landscape. The S&P 500 is far more important, and it is still some 1.6 per cent shy of a new record high. By another measure, U.S. stocks rallied to new heights a couple of weeks ago: The Russell 3000 index, which represents 98 per cent of the investable U.S. equity market, surpassed its 2007 peak on Feb. 19. It hit a fresh record high on Tuesday – a more important milestone than the Dow’s record, but virtually ignored amid the Dow euphoria.Report Typo/Error