A Decade of Decline in Equity Markets

Includes: DIA, GLD
by: Disruptive Investor
The Dow Jones Index was trading at 11,357 levels at the beginning of the year 2000. More than a decade later (as of beginning July 2011), the index is at 12582. Therefore, the index has gained 11% in the last ten years.
However, I wish to discuss a decade of decline in Dow Jones index during the same period (2000-2010). This might sound weird, but I have evidence to show that the real market crash has been very effectively hidden through expansionary monetary policies in the last ten years.
It is of utmost importance for investors to understand that any asset class can be supported at higher levels if there is enough liquidity provided in the system. The same has been the case in the last ten years when the U.S. has witnessed significant quantitative easing.
Therefore, in such scenarios, looking at the value of the asset class in terms of paper money does not give the real picture. In an environment characterized by excessive quantitative easing, it is necessary to see the value of asset classes against hard assets (whose supply can’t be increased at the pace of paper money).
One can choose any hard asset in order to determine the real value of the index, which shows gains in nominal terms. In this article, I chose gold as that asset primarily as the precious metal is very much in news these days (for making new highs).
The chart below gives the Dow-Gold ratio for the last ten years:

Click to enlarge

From the chart, the following is observed:
a) In January 2000, one needed to have 39 ounces of gold to but one Dow Jones index. Since that period, the ratio has been gradually trending downwards. As mentioned above, post the year 2000, the interest rates have been artificially low on numerous occasions allowing significant flow of paper money in the markets
b) As of July 2011, one just needed to have 8.5 ounces of gold to buy one Dow Jones index
c) In other words, the Dow Jones index has crashed by 78% during this period. This crash has virtually gone unnoticed
The chart also shows that gold has been a far superior investment in the last decade to the Dow Jones index. More importantly, since the policy action remains the same (tilted towards more quantitative easing); gold will still remain a superior investment option.
The important thing for investors to consider is the real value of their investment. If enough money is printed, the Dow Jones might go ballistic and investors will make money in nominal terms. But, if one considers the real gains, it might be negligible or negative.
In my personal opinion, we might witness another decade of decline in the index (against hard assets). Hence, investors need to build their portfolios accordingly.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.