The market can be enigmatic at times and the Dow's more than 50% rally so far this year from the March lows has many scratching their heads. Sometimes it is hard to believe that the Dow is now straddling the 10,000 level considering all that is still wrong in the economy. The last two times we hit 10,000 on the Dow while going upward, the market was very different as we can see here:
For many, this is hard to justify and anyone would admit there is still a lot for the market to live up to. However, one explanation that could give some credence to the Dow being at 10,000 is the effect of inflation. Liberal use of money by the Federal Reserve and the Federal Government has certainly enlightened most of us to the fact that the dollar is losing its value. Hundreds of billions of dollars of bailout spending and money printing doesn't come without a cost, after all, but I'm sure you've heard this all before. You're probably aware that certain commodities have been on a tear as well, but as a refresher, below is a chart of the dollar (measured by the UUP ETF in dark blue) compared to oil (blue) and gold (green). Oil prices have broken through $75 per barrel, while gold continue to trade above $1,000 and sets daily records.
So in general, we are already seeing the effects of inflation, and to buy less now costs more. Anything measured in dollars is susceptible to inflation, and that includes stocks which may partially justify the stupendous rally we are experiencing. I took the liberty of gathering the Dow's daily closing values since February as well as the daily dollar value, and then adjusted the Dow to remove changes in the dollar. Upon doing so, the market rally looks a lot less impressive. As the Dow has taken off towards 10,000 in nominal dollars so has the adjusted index, but far more gradually. In fact, in chained dollars the Dow has merely bounced along a ceiling for the past couple of months. So perhaps the oncoming bout of inflation is a blessing in disguise for the stock market, but then again the proceeds from your market winnings aren't going to go as far at the gas pump, etc. so it all comes back full circle eventually.
Perhaps I sound like a smart-aleck trying to discredit the market rally and to a small extent I am, seeing as fundamentals alone seem not to be enough to justify this rally. Don't get me wrong, the main drivers of the market are still going to be economic reports and corporate earnings and over the past several months the news has been good enough (although still bad) to send the market higher but it can still be hard to justify the Dow being at 10,000. I hate to overuse the term "less bad" but that is exactly what we have been getting during the current quarter with respect to economic and earnings releases. Throw in inflation and current values may actually be justified, so in that sense you should not be afraid to jump into the market now just because it looks like its overvalued. But, just remember that you may be paying more for less, just as with gas and gold.