Balaji Viswanathan

Could the Dow Fall to 1600?

Those are very good points Robert. I didnt account for inflation because the inflation roughly cancels the dividends from the stocks. The normal dividend yield is between 3 to 8% and that more than accounts for the inflation. So, my reasoning was that the growth in market cap after reducing dividends is more directly comparable with the growth in chained GDP value.



On Mar 03 12:53 PM Robert H. Heath wrote:

> timhope is right. You're using the real GDP in chained-2000 dollars.
> Here's the link to nominal GDP.
>
> research.stlouisfed.or...
>
> Nominal GDP grew 53.4x from 1949 through 2008. In 1949 GDP was $267.3
> billion. In 2008, it was $14,264.6 billion. That's a 7.0% compound
> annual increase.
>
> Real GDP has grown 3.4% over the same period, a 7.1x increase.<br/>
>
> Inflation accounts for the difference, having grown 3.8% per annum
> over the same period (This is CPI-all urban. PCE deflator data does
> not go back to 1950).
>
> The fact that the DJIA tracked GDP prior to the 80's and then diverged
> probably has more to do with monetary policy in the two periods than
> anything else.
>
> A few more cautions about this sort of analysis.
>
> There are a number of disconnects between the level of a stock market
> index and the size of its home economy.
>
> 1) You mention the influence of international trade. That is surely
> important over a time series when companies become more global, earning
> profits overseas that do not show up in home country GDP.
>
> 2) Using a stock market index for this analysis will almost surely
> mislead.
>
> It makes some theoretical sense that the total VALUE of traded stocks
> might have some constant relationship to the size of the economy
> over time, but you should look at the market capitalization of the
> companies in the index, not the index itself (subject to the following
> additional qualifications)
>
> 3) The DJIA is a particularly poor index to use for this sort of
> analysis as it consists of only 30 stocks, and is price-weighted
> rather than market cap weighted. Far better to use the S&amp;P 500
> or the Wilshire 5000.
>
> 4) Even adjusted for market capitalization, stock market indices
> (especially the DJIA with only 30 stocks) may exhibit "survivor bias"
> over long periods in the sense that poorly performing companies whose
> continued inclusion would pull the averages down are generally replaced
> by companies with brighter growth prospects.
>
> 5) The total value of publicly traded stocks (vs. privately held
> businesses) can change over time, reflecting the relative attractiveness
> of being public vs. private or the development of advanced markets.
> So for example, In 1950, Ford Motor Company was still a private company...
> It did not go public until 1956. So while there is probably a stable
> relationship between the total value of all businesses, -- public
> and private -- and GDP, you may be missing a variable if you look
> only at public values vs. GDP.
>
> 6) Corporate profitability can vary substantially over long observation
> periods, especially if there are changes in the tax burden falling
> on corporations vs. individuals.
>
> 7) Dividend policy can change dramatically over long periods, usually
> in response to tax rates on dividends vs. capital gains. Unless your
> index is rebased for dividends, significant changes in dividend payout
> ratios will lead to tracking error between the index and the profitability
> of the companies within it.
>
> I'll stop here.
>
> Even with all the disclaimers above, I'll re-run the analysis using
> nominal (not real) GDP.
>
> The Dow started 1950 around 200. As mentioned above, GDP has increased
> to 53.4x the 1949 level. 53.4x 200 = 10,680.
>
> That's not my price target for the DOW and please don't misread this
> as a bullish recommendation. But I'm not to worried about seeing
> 1,600 on the Dow soon.
>
>