On March 5th this year the Dow Jones Industrial Average closed at a record breaking high of 14,253.77. Just under one month later, the broader-based S&P 500 followed suit as it set a new milestone, closing at 1,569.19 on March 28th.
Both indexes continued to set records into April, but amid the celebration on Wall Street there was caution and confusion as analysts puzzled over this decidedly bullish market, especially as the wider U.S. economy was still struggling to pick up speed.
With no way to predict the direction of the stock market, records are often seized upon to confirm or disprove prevailing trends and theories.
But can they really offer anything more than a snapshot of where markets are at a given moment?
And do they hold any relevance to the broader economic outlook?
Back To The Future?
The Dow and the S&P 500 both set their previous records in October 2007 during a time of apparent prosperity. Real gross domestic product (GDP) had grown at an average annual rate of 3.6% and 3% in the second and third quarters of 2007, and the unemployment rate in October was 4.7%. Just two months later, the Great Recession began and the stock market lost more than half of its value by the time it hit bottom in March 2009.
On one level, therefore, the recent records mean that the market has regained the value it lost in the intervening years. In theory, based on the Dow and the S&P 500, investors who remained invested in the market may have regained the value of their stock portfolios.
That’s the good news.
The bad news is that investors may have lost over five years of potential growth. The crucial element is whether or not the market, having returned to pre-recession levels, has the staying power to continue helping people rebuild their assets.
Record Profits, Fewer Workers
The stock market is generally considered a leading indicator, meaning it may predict future economic trends. If true, the recent record performances would suggest that the economy may be picking up steam. Among the factors pushing stocks into record territory were expanding factory activity, higher spending by businesses and consumers, and signs of recovery in the housing market.
In October 2007, however, the market did not seem to reflect the negative economic forces that were at work.
A key concern in the current situation is the economic disconnect between large American corporations and American workers, in part a direct result of the recession, which forced businesses to become more efficient and increase productivity with fewer employees.
Since the end of 2008, corporate earnings have risen at more than a 20% average annual rate, while disposable income rose just 1.4% annually. In the third quarter of 2012, profits accounted for the highest share of national income since 1950, whereas wages as a percentage of income dropped to near the lowest point since 1966.
Although the unemployment rate has improved, the 7.6% March 2013 figure is almost 3% higher than in October 2007. A leaner workforce may be good for the bottom line, but it remains to be seen whether American businesses can continue to grow with a high percentage of unemployed consumers.
Low Rates, Unforeseen Events
Low interest rates promoted by Federal Reserve monetary policies have also played a role in helping businesses grow in a sluggish economy. The Fed has committed to these policies until the unemployment rate drops to 6.5% and inflation appears poised to exceed 2.5%. So far both benchmarks have remained out of reach, although some analysts believe that rates may rise rapidly when the Fed eventually tapers off its stimulus efforts.
As you consider your own investments, remember that market trends reflect expectations as much as economic reality, and expectations can change on a daily basis. Although records may be exciting, the wisest course is generally to maintain an investment strategy that is
appropriate for your personal situation and risk tolerance.