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The DJIA Fallacy

The news media are full of people just like you and me, in one sense – they are human. One thing about humans, our brains are quite lazy. This is not to say that we are dumb or that we cannot figure out great complexities, we did send men to the moon, split the atom and, how to refrigerate air. As Cousin Eddy reminded us in Vegas Vacation, those of us living in the Southwest are “lucky [we]‘ve got air conditioning…like Mother Nature intended.”

The wonders of being able to crank the air temperature down to a cool sixty-eight degrees inside, while the scorching hot sun cooks asphalt to a blistering sixty-eight thousand degrees, is beside the point of this article no matter how amazing and life fulfilling it is (if ever there is a zombie-apocalypse I will worry more about no A/C than I will about the flesh eating corpses).

Okay, enough about modern life affirming miracles of science and back to something else. Ah yes, the human mind. Researchers like Daniel Kahneman have shown that we have two brain systems. Our default setting is to have the reactionary and impulsive quick thinking part of the brain make the initial decisions. All living things with a nervous system have this function. It is what saves us from danger. It is also the part that doesn’t have to work all that hard. Humans have developed a stage two brain that takes lots of energy to use and is what gave us the ability to change our environment so that we could pump quarters into a slot machine for eight hours in cool comfort while the sun cooks the Nevada desert to a horrifying temperature during the middle of August.

The first stage brain likes to use shortcuts and cues from others to make decisions. Because of this laziness, when the news reporter wants to describe the state of the economy they use shortcuts like the Dow Jones Industrial Average (DJIA.) As a formerly practicing Certified Financial PlannerTM Practitioner, I would rarely, if ever, use this average as a benchmark for analyzing stocks. However, the media loves to show the DJIA as an indicator of economic conditions. This is the fallacy of the DJIA.

So what is the DJIA exactly? It is a statistical average of the thirty largest (by market capitalization) companies in America. Companies like Boeing, 3M, Chevron, GE, and even non-industrial companies like Bank of America and American Express. The highest closing price ever for the Dow was achieved on April 10, 2013 reaching $14,802. Compare that to the point reached at the bottom of the great recession of $6,547. This average will take the trend of the overall economy, and I emphasize trend, but that $14,802 level does not actually represent the overall economic condition of the USA.

Not long ago, the Los Angeles Times reported that “many U.S. companies are still hanging on to record amounts of cash, something they usually do in times of economic turmoil.” The article continued to say that “U.S. companies held $1.45 trillion in cash in 2012, up 10% from the $1.32 trillion they held in 2011 — which at that time was a record level, according to a new report from Moody’s Investors Service.” Along with holding on to record amounts of cash the Federal Reserve is going through Quantitative Easing policies like a drunk goes through cans of Keystone beer. Basically the Federal Reserve buys bonds from the Treasury with printed money, so that the Treasury can operate in deficit spending.

This has the effect of injecting liquidity (cash money) into the economic system. If unchecked this printing and pumping of cash can cause disastrous inflation (as witnessed during the Weimar German Republic which led to WWII; as well as in Zimbabwe currently). Luckily for us right now, a lot of this money is being hoarded by these companies so it is not doing much to the economy in terms of inflation, but once Obama is gone and our system begins to iron out all of his destabilizing policies, this money will flood the economy and Katy bar the door, because inflation will hit the economy like a bomb on August 6, 1945.

This is another discussion for another day, however. Some of the money from the QE garbage is making its way into the economy; it’s not all being hoarded. Some people are being hired, some people are investing, and some people are saving for retirement. So where do you suppose people want to invest their money if they have it?

Would you want to invest in a small start-up internet company that is being hammered by Obama’s policies like Obamacare where they can barely afford to keep the doors open let alone expand, create wealth, or benefit stockholders? Or, you might rather invest your savings in a bond market that has low interest rates because Fed policies are keeping them low artificially through buying, buying, buying of Treasury debt? Better would be to invest in a stable company with extraordinary profits that is sitting on more cash in reserves than the US Treasury itself. I am of course speaking of companies like Apple which alone has nearly $75 billion in.

To put this all together, we have an economic environment where the only safe and profitable place to invest is in big companies on the DJIA. Because there is a glut of cash in our system looking for places to save, rather than being consumed through buying activity, we have what is known as demand for DJIA stocks. Demand, as we know from ECON 101, pushes prices higher as the supply reduces. This is why we cannot look at the DJIA and say that since it is reaching record highs our economy is roaring. We still have high unemployment, record levels of people who have stopped looking for employment, record levels on disability, food stamps, and other welfare programs. Companies are not investing in expansion of their businesses, and we are still importing illegal aliens looking for jobs at record levels.

There is nothing about our economy that tells us we are in good shape, and that especially includes the DJIA.

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