What Does the Dow Really Measure?

The Dow Isn't Really At A Record High (And It Wouldn't Matter If It Were) ... Just a quick, cranky reminder: Despite what you may have read, the Dow Jones industrial average did not hit a new high today in any meaningful sense. After adjusting for inflation, the Dow was higher in 2000 than it is today. It was also higher in 2007. It would need to rise another 10 percent or so to hit an all time high in real (i.e., inflation-adjusted) terms. – Planet Money/NPR

Dominant Social Theme: The recovery is humming along.

Free-Market Analysis: As we mentioned in another article, today, the US is increasingly operating as a two-track society and simply observing the price of the Dow Jones Industrial Average does little to enlighten us about the real health of the US economy.

While NPR is not usually a bastion of financial literacy, this article posted at Planet Money is surprisingly candid about the realities of the DJIA's numbers and what they mean.

While a stock market average like this one is certainly representative of the progress of some of the US's largest companies, the figures do not necessarily imply that a solid recovery is underway. Here's more from the article.

When reporting on other numbers that change over time, it's routine to adjust for inflation. So when people talk about wages stagnating for American households, it means that, after you adjust for inflation, the median wage is roughly the same as it was 15 years ago. If you didn't adjust for inflation, you would say the median wage has risen by more than 40 percent over the past 15 years. But that would be a meaningless statement.

It's equally meaningless for the Dow. And even if the Dow did hit a real, inflation-adjusted, all-time high, it wouldn't mean much anyway. As our colleague Adam Davidson wrote last year:

The Dow average, drawn out to two decimal places, may seem like some perfectly scientific number, but it's far from it. A small committee selects 30 big companies — I.B.M., G.E., McDonald's, Disney and so forth — and then adds up the price of their stocks. Then the analysts divide it by the Dow Divisor, a misleadingly precise-seeming number formulated to account for things like dividends and splits that right now is, well, about 0.132129493. The resulting figure is repeated throughout the country.

And those are the least of the Dow's problems. More troubling is that it ignores the overall size of companies and pays attention to only their share prices. This causes all sorts of oddities. ExxonMobil, for example, divides its value into nearly five billion lower-cost shares, while Caterpillar has around 650 million more expensive ones. Therefore ExxonMobil, one of the largest companies in history, pulls less weight on the Dow than a company less than a fifth its size.

Looking at stock market averages and extrapolating significant conclusions from them may have been slightly more justifiable 50 or 75 years ago when monetary stimulation was less intense. But today, evidently and obviously, the stock market run-up in the US has been mainly the result of the various quantitative easing that the Fed has embarked upon.

As the NPR article points out, when these numbers are adjusted for inflation, they are still below the numbers that the markets achieved in 2007. But even this is misleading because the market achieved those numbers via additional intense Federal Reserve pump-priming.

In 2007, market averages were at an all time high and by 2008 the US economy – and the West's – were in ruins. This should be enough to do away with the idea that the stock market itself is an indicator of national prosperity. It is not.

The stock market is easily manipulated by money flows. When central banks generate large money flows via their printing presses, some of this money inevitably finds its way into the financial markets and pushes them up. The mainstream media then does its best – as instructed – to explain these averages are a sign of recovery.

In the 21st century, however, stock averages are more disconnected from underlying economic realities than ever before. In some sense, one could argue that the Dow currently measures the volume of financial manipulation rather than the underlying health of the economy.

Conclusion: Increasingly, one should look to other indicators to determine economic health, including overall GDP, the employment rate and even the number of people taking advantage of private charity and public assistance programs. Here, the news is certainly not good.