Saturday, February 16, 2013

Is the Recovery in the Dow Jones an Illusion?

It has been reported that the Dow Jones Industrial Average (DJIA) last week reached a four year high not seen since before the onset of the financial crisis. Just one look at this graph shows that this is true, and that the DJIA is within striking distance of reaching its all time daily high of 14,164 which it hit on October 7, 2007.

This chart seems to be saying that anyone who invested in the Dow during this 50 year run has much to celebrate, especially given the fact that this chart shows levels of the Dow and does not try to calculate holding period returns which would be even better once you include dividends paid each year. It also suggests that people who bought and held during the crisis were rewarded as the Dow rebounded from its crisis low of 6,627 on March 6, 2009. But does this graph tell the whole story?

Here is the same graph of the DJIA, but now adjusted for historical consumer price inflation. Suddenly, the recent trend line is not so obvious.
I would argue that adjusting the DJIA solely for historical consumer price inflation does not tell the whole story. The Consumer Price Index, by definition, can only tell you about historical inflation. Other assets that can act as long stores of wealth move in price not only to reflect historical inflation, but investors' best estimate of future inflation as well. We see that these long maturity assets move up in nominal price reflecting expected future inflation long before consumer prices ever start to move up.
So, it only seems fair to compare the DJIA as a store of wealth to other long assets to see how it did in preserving its purchasing power relative to these assets. Maybe the Dow's recent run-up in nominal price is just reflecting greater expected inflation in the future similar to what is driving gold and other commodity prices higher.
Here is a picture that shows how the DJIA has done if priced in gold ounces instead of US dollars.

Where did the big rebound go from the crisis's depths in 2009? Where is this new high that everyone is talking about? And what has happened to our country's stock market wealth since 2000? READ MORE

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