What Does the Dow’s Record High Really Mean?

Does it signal anything more than bullish sentiment?

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 Americans, the Dow equals the stock market, and the stock market is a direct
product of the economy. It doesn’t quite work that way, of course. Right now,
it is worth examining some of the factors that have driven the Dow to its
series of record closes. Does the Dow’s impressive winter rally signal anything
more than unbridled bullish enthusiasm?

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. 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”, the reference is to the S&P. As
the Dow kept settling at all-time peaks in early March, the S&P was consistently
wrapping up trading days at 5-year highs but still remained about 2% off its 2007
record close.2,3
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.1
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 x 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 the Dow
Divisor, which is a numerical value computed and periodically adjusted by Dow
Jones Indexes. For every $1 that shares of a DJIA component rise in price, the
value of the Dow rises 7.68 (the Dow Divisor, you see, is well beneath 1 – on
March 7 it was 0.130216081).4,5,6
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 a
comparison between 2007 and 2013 a bit hazy.1
The big picture.
The Dow surpassed its old record thanks to many factors – the resurgent
housing market, the Institute for Supply Management’s February purchasing
managers indices showing stronger expansion in the manufacturing and service
sectors, an encouraging ADP 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. The parallel, open-ended effort
of the European Central Bank has diminished some of the anxiety over the future
of the euro. In early March, the ECB and the Bank of England again refrained
from adjusting interest rates and ECB president Mario Draghi mentioned the need
for the bank to retain an “accommodative” policy mode until the eurozone economy sufficiently improves.3
In the big picture, two perceptions are moving the market higher. One is the conclusive 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 sustained bullish
sentiment.
How high could the Dow go? Any time the Dow
flirts with or reaches a new record high, bears 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.
While the market has soared in the first quarter, the economy grew just 0.1% in the fourth
quarter by the federal government’s most recent estimate. That may have given
some investors pause: the Investment Company Institute said that $1.13 billion left
U.S. stock funds in the week of February 25-March 1, which either amounts to
bad timing, an aberration (as it was the first outflow ICI recorded this year),
profit-taking or skittishness.7

If the Dow hits 14,500 or 15,000, that 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 Main Street certainly takes note of that. Lazard
Capital Markets managing director Art Hogan seemed to speak for the status quo
in a recent CNBC.com article: “We’re certainly in an environment where good
news is great and bad news is just okay. The market has just found the path of
least resistance to the upside in the near term and it’s hard to find something
to knock it off there.”7
Reeve Conover can be reached at 877-423-9990 or Reeve@ReeveWillKnow.com

 

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Citations.

1 – business.time.com/2013/03/06/dow-jones-closes-at-record-high-so-what/
[3/6/13]

2 – www.nyse.com/content/faqs/1050241764950.html
[3/7/13]

3 – money.cnn.com/2013/03/07/investing/stocks-markets
[3/7/13]

4 – www.dailyfinance.com/2013/02/28/dow-14000-economy-meaning-djia-explainer/
[2/28/13]

5 – www.investopedia.com/terms/d/dowdivisor.asp#axzz2MtpUOJVi
[3/7/13]

6 – online.wsj.com/mdc/public/page/2_3022-djiahourly.html
[3/7/13]

7 – www.cnbc.com/id/100533269
[3/7/13]