All time high for U.S. stocks? Hooray but why should we care?

03/12/2013 8:30 am EST


Jim Jubak

Founder and Editor,

If you need to sell papers, you splash headlines like “Brits to leave European Union over horsemeat in lasagna” across your front page even if they’re total exaggerations.

When Wall Street wants to flog stocks, it runs out stories like “Dow Jones Average hits all time high” even if the story doesn’t mean what Wall Street wants the average investor to think it means.

So, yes, the Dow Jones Industrial Average hit an all time record high price on Monday when it briefly moved above 14,448. The Dow Transportation Average and the Russell 1000 large cap index and the Russell 3000 small cap index have all hit all time peak prices. The Standard & Poor’s 500 stock index is within 1% of its all time high price set in 2007.


I can think of four reasons why the “all-time high price” recorded yesterday doesn’t mean what Wall Street and the headlines say it means.

First, while I think it’s great (and I’m certainly not giving back any profits I’ve made lately) that prices of U.S. stocks have by and large returned to the levels of 2007—or even beyond—I’ve got to ask “That’s all? That’s all we get from an unprecedented flood of central bank cash?” The Federal Reserve’s balance sheet now exceeds $3 trillion, up from $488 billion in January 2011. The European Central Bank’s balance sheet hit what I think is likely to be a temporary peak of $4.2 trillion in June 2012, up from $2.98 trillion in June 2011. China has been printing money. Japan has been printing money. And this money poured into a global economy where growth was so slow and economic conditions so uncertain that much of this cash went into financial assets rather than into capital or consumer spending. All we got from this is a return to the stock market levels of 2007?

Second, U.S. stock prices are only at new highs if we forget about inflation. In other words these are nominal rather than real highs. Adjusted for inflation, the level of the Dow Jones Industrial Average is still 10% lower than at its 2007 peak. Adjusted for inflation that 2007 peak wasn’t actually a peak either since—adjusted for inflation—the 2007 “peak” is lower than the 2000 high. So far, what investors have—if they adjust for inflation—isn’t a series of ever-higher peaks, but of ever-lower highs. The 2007 peak was lower—once you’ve adjusted for inflation—than the 2000 peak. And so far, the 2013 peak is lower than the 2007 peak.

To date what we’ve got is a classic bear market pattern of lower highs. Maybe the 2013 rally can break that pattern—once the price of U.S. stocks is adjusted for inflation, of course--but we aren’t there yet. From this perspective, there’s a lot riding on this rally—the difference in real terms of a continuation of the bear market that began in 2000 and a move onto either an actual bull market or at least a consolidation that might launch a new bull market. But despite the yelling about new highs for U.S. stock prices, we aren’t there yet.

Third, if you think calculating the inflation adjusted price level of the Dow or the S&P takes a little luster off the current claims of an “all time high,” you should see what happens to stock market prices when they’re compared to other assets. If, for example, you measure the gain of the S&P 500 in terms of gold—and not U.S. dollars—the price of the S&P is down 53% from the 2007 high.

And, fourth, why all this focus on the prices? Sure, stock prices are an important component of gains for investors, but they’re only a component.  Over time about 40% of the total return for the Dow Industrial Average has been in the form of dividends. If those dividends were reinvested, then dividends account for 50% of the total return on the Dow Jones Industrial Average. If you include the dividends from the Dow stocks in your calculations, then the Dow Jones Industrials—even adjusted for inflation—hit a new high in February 2013. (Besides the famous Dow Jones Industrial Average that business sections report so prominently, there’s also a Dow Jones Industrial Average Total Return Index (DJITR: IND) that includes dividends from the Dow stocks. Chart the two against each other to see the difference that dividends make in total return.)

What’s my point? I’ve got several actually.

What we’re seeing right now is a rally fueled, as the post 2000 rally was fueled, by central bank policy. Put enough money into the global economy and stock prices—in nominal terms—will go up.

But I think it’s way too early to declare that the real problems in the global economy in 2000 and 2007—ranging from too much central bank cash to global aging to inadequate systems for recycling cash from the Middle East and China to policies that damped domestic demand while goosing exports—have been solved in 2013. I’m pretty sure that we can’t yet declare victory in the Great Recession since the specter of a repeat of 1937 still hangs over the global economy. 1937—as Federal Reserve chairman Ben Bernanke knows well—is the year that over confidence in a U.S. economic recovery led Congress and the President to aim for a balanced budget in the belief that the Great Depression was over. That mistake ushered in another economic downturn that wouldn’t itself be ended until the “economic stimulus” known otherwise as World War II.

What worries me about the current rally is that the fuel—central bank cash—may be running low. It took massive cash flows from the Federal Reserve and the European Central Bank to get stocks to this level. The Federal Reserve isn’t looking to expand its balance sheet further but increasingly has its eye on an exit from quantitative easing. The politics of the European Central Bank say that the bank won’t send another wave of cash into the European financial system unless the crisis worsens drastically in Italy, Spain, and France. The Bank of Japan will add its own program of quantitative easing to the global soup later in 2013, I believe, but that’s likely to be the last big move from the global central banks.

At the same time as the central bank cash that has fueled this nominal rally is becoming scarcer, inflation may be ticking up modestly in China and is likely to move higher intentionally in Japan in the not too distant future.

I’m not willing to say that this rally is going to end tomorrow—I think it will take an external shock like a bad turn in the euro debt crisis in, say, June—but I do think the odds against this rally are rising.

In this situation I think a high but sustainable dividend from a company that seems committed to a policy of raising dividends over time is about the best hedge that you can have. Dividend stocks with high but sustainable yields tend to fall less when a rally busts although they do fall. The dividend gives investors a solid return while they wait for stock prices to recover and investors will get a chance on any price decline to pick up shares of a high dividend stock that they know well with what is now a higher yield. And, finally, companies with histories of investor-friendly dividend policies tend to be very aware of inflation and raise dividends to keep ahead of rising inflation as long as it doesn’t get completely out of hand.

On recent history, investors need every edge they can get to generate a positive inflation-adjusted return from stocks. And that means using dividends too. I’ll post an addition to my dividend income portfolio that will help you do that on Wednesday, March 13.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund , I liquidated all my individual stock holdings and put the money into the fund. For a full list of the fund’s holdings see the fund’s portfolio at
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