April 11, 1997
"Is the Dow Too High? No"
San Jose Mercury News
By Timothy Taylor
<< Back to 1997 menu
AS THE Dow Jones Industrial Average zoomed past 7,000 in early March, it seemed
only a matter of time until the roller coaster came back down. But the belief
that stocks will inevitably fall to earth may reveal more about our difficulties
in understanding growth and inflation, rather than having anything to do with
Consider these facts: From 1960 to the present, the gross domestic product
of the U.S. economy has risen from $526 billion to about $7.7 trillion; which
is a fourteenfold increase. Over that time, the Dow Jones Industrial Average rose
from 618 in 1960 to just over 7,000 in early March, only an elevenfold increase.
Other indexes show stocks rising at about the same speed. The New York Stock
Exchange index rose from 30 in 1960 to a peak of 420 in early March, a fourteenfold
increase. The Standard & Poor's composite index went from 56 in 1960 to a
peak of 810 before the declines of the last few weeks, again a fourteenfold increase.
In short, over the last few decades, the stock market has risen at about the
same rate as the overall economy! Thus, to think about whether the Dow is unsustainably
high at 7,000, it's useful to think about whether the gross domestic product has
grown unreasonably high at $7.7 trillion.
Inflation, which has raised prices by a factor of five since 1960, is one reason
the economy looks bigger. But although I am mildly shellshocked by today's $7
movie ticket, I don't expect price levels to crash back to their 1960 levels.
The U.S. population has risen from 180 million in 1960 to almost 270 million
today, a rise of 50 percent, which has expanded the economy in its wake. Although
I do feel that some of my favorite outdoor haunts are becoming more crowded, I
don't expect population levels to decline.
Finally, the real economy has also tripled since 1960 because of real gains
in productivity and technology. Although I am frequently astonished at what is
now possible in medicine, computing, home entertainment and many less visible
areas of the economy, I don't expect a technological reversal. But if inflation,
population growth, and new technology are reasonable causes of a larger economy,
they are equally valid causes why the stock market based on that economy will
be higher as well.
Of course, the stock market will not move in lockstep with the economy. Various
factors like taxes and interest rates, expectations about profits, changes in
patterns of corporate finance, and the presence of inflation or recession will
matter greatly. The stock market moves in fits and starts. For example, the Dow
Jones Industrial Average rose by 50 percent from 1960 to 1972, then dropped 7
percent from 1972 to 1982, before taking off on its 15-year expansion to the present.
Thus, another way of thinking about the run-up in stock prices these last few
years is that, sooner or later, the market had to catch up for its relatively
dismal performance during the 1970s.
This volatility in prices doesn't mean that stocks are a poor investment. Remember
that higher stock prices are only one way of making money in stocks; many companies
also pay dividends, which add to investors' returns. But it does mean that investing
in stocks requires taking a medium- to long-term horizon -- say 10 years or more
-- and having a strong stomach for riding out the waves.
When you have your retirement money entirely invested in stocks, as I do, it's
a little sickening to watch the market fall. Even if I were foolish enough to
predict where the stock market will head in the next few weeks, I hope and trust
that you would not be foolish enough to invest any money based on my prediction.
The stock market offers no short-term, money-back guarantees. But for the typical
small investor, who is in no position to joust in the stock market with the savvy
professionals at gargantuan pension and mutual funds, suffering through the downs
of the stock market is the easiest way to be in a position to take full advantage
of the ups.
<< Back to 1997 menu