Beware the wobbly stocks ladder
T o much acclaim, the Dow Jones Industrial Average recently passed the 14,000-point mark for the first time in five years, a supposed signal that the economy is back on track.
A few days later, the Commerce Department reported — unexpectedly — that the nation's Gross Domestic Product had contracted by 0.1 percent in the fourth quarter of last year, a signal that all might not be well.
The move into stocks that boosted the Dow has been led by financial institutions purchasing stock mutual funds. In contrast, individual investors have merely dipped their toes into direct purchases of individual stocks.
Yet, financial news media have commented ecstatically on rising stock markets — some even forecasting that the slow-growth aftermath of the Great Recession finally is over. As a result, individuals who, for the past five years have been trying to repair their broken balance sheets, may be tempted by stellar gains in equities to think of participating more aggressively in stocks.
My advice: Be very careful.
Why? Mainly because little or no account is being taken of inflation. Most commentators dismiss inflation as virtually non-existent right now. Admittedly, another recession appears the bigger risk facing the economy.
The Bureau of Labor Statistics oversees the calculation of the Consumer Price Index (CPI) and reports that inflation has been hovering at below 2 percent over the past five years. Consumers buying food, goods and services such as health care in the real world, know better. They likely would agree as more accurate some higher private assessments — including those by John Williams' Shadow Government Statistics newsletter — of a more realistic inflation rate of between 6 percent and 10 percent.
The fact is, taking the average low inflation rate of the CPI since 2007, the Dow index now would have to be around 15,469 today to equate to its record high of 14,165 set on Oct. 9, 2007.
A number of factors can create an overly optimistic picture of the economy and the stock market. One is this unrealistically low rate of inflation, and another is the exclusion of the effect of enormous repurchases of their own shares by big corporations. Purchases of so-called “treasury stock” raise earnings per share, support the price of a company's shares and decrease the number of its shares in the marketplace, helping to further increase share prices.
All the while, the Federal Reserve continues to inject more synthetic dollars into the system with its campaign of bond purchases.
Some economists believe stock markets have risen too fast. According to Capital Economics, the increase in stock prices over the past 12 months (+16.8 percent) is third behind the Eurozone (+18.6 percent) and Japan (+28.6 percent).
Media commentators contend that investment by individuals is a bearish sign. Robert Hapanowicz, a financial adviser with H&A Wealth Advisors in Pittsburgh, points in a recent report to an increase of individual investment in stock mutual funds as proof of rising stocks. However, this activity is reflected as institutional buying, not individual or “retail” purchases.
Profit potential from stocks certainly remains tempting. Only when retail investors start to buy individual stocks directly does history suggest a market downturn is on the horizon.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at firstname.lastname@example.org.