3 Ways The Dow Is Lying - What Does It Mean?

Includes: DIA
by: Wall Street Wisdom

The Dow Jones Industrial Average is at a record high and the unemployment rate has ticked down to 7.7% percent, but this is no time to celebrate. The economy is still in the doldrums.

A little perspective: The news media trumpet changes in the Dow as if it tells us almost all we need to know about the economic fate of the American people. That's nonsense. Not everyone thinks the arbitrary index of 30 busily traded blue-chip stocks is terribly relevant to gauging the condition of the economy. Here are three reasons why the success of the Dow is lying to us.

  1. The average, which reflects the daily change in the companies' stock prices, is not adjusted for inflation. In nominal terms, the Dow hit a record high of 14,447.29 this month. But in real adjusted terms, the average is only at the level reached in 2000. In other words, if you invested in the companies that year, you're no richer now because the dollar has depreciated thanks to the Federal Reserve. That doesn't sound so remarkable.
  2. Fixation on the Dow might encourage neglect of other, less upbeat economic indicators. While the DJIA soared, the unemployment rate dropped to only 7.7% last month. That is disturbingly high, especially when you consider that the Great Recession officially ended more than three and a half years ago.
  3. Even more light is shed on the employment picture by looking at the civil employment/population ratio. According to the Bureau of Labor Statistics, before the recession the rate was over 63%. During the recession, it hit a low of slightly over 58% and has barely recovered since. (In the late 1990s it was close to 65%.)

In light of such dismal signs, how are we to account for the stock market? The Federal Reserve is working hard to keep key interest rates close to zero; it has bought hundreds of billions of dollars in long-term government securities (Operation Twist) in order to lower the return from such investments. This drives money seeking a bigger return into the stock market and commodities. If this explains the run-up in stock prices, it sounds more like a bubble than a marker of returning economic growth.

The government and its central bank, in fact, have done virtually everything wrong if their intention was to put the economy on a sustainable path to prosperity. The recession was caused by distortions created by government housing and monetary policies. Instead of backing off and letting the economy realign with real economic factors, the Obama administration and the Bernanke Fed seem intent on re-inflating the pre-recession housing bubble, as well as inflating a new stock market bubble. (The Fed has also been buying up mortgage bonds from banks to help stimulate housing sales.)

This is a dangerous path. By definition, such artificially induced frenzies cannot be sustained. When officials get nervous and pull back, the bubbles will burst and the economy will be back in recession. Even if employment gains are made during the apparent recovery they will be short-lived, and the unemployment rate will turn up again. This government policy, therefore, is a cruel hoax on workers who were harmed by the earlier recession, who have struggled to get back on track, and who are now being set up for a reprise of their misery.

Simply put, it is impossible for politicians, bureaucrats, and economic advisers to acquire the knowledge they would need to possess in order to accomplish what they say they want to accomplish. The most vital knowledge for smooth-running markets is not aggregate statistical data available to government agencies. Rather, it consists in the subjective preferences of consumers, the expectations of producers, and the radically decentralized and dispersed information about resources, technologies, and techniques. The next five years could be the most foretelling time in our countries history. If the Obama administration and the Fed do not figure out an alternative that actually inflates on real productivity growth, we could be in for a long, tumultuous downturn.

What Does It All Mean?

With the promulgated "Sell in May and go away," upon us, I would caution investors to pay extra attention to the market over the next couple of weeks. I do not claim to have any genius eccentricities or clairvoyant abilities that allow me to predict the future, but I think we are all smart enough to realize that if you are pumping money into a lackluster economy with little productivity to back it up, there will be serious repercussions. According to Money Magazine, 78% of Americans will experience a life-altering event in any given 10-year span. Most analysts predict that with the current economic status we will experience another recession between 2013 and 2015, and the damages could be worse than ever before. But the numbers don't lie, and if there is any single thing that I know for sure it's that the first step to fixing any problem is acknowledging that there is one.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.