The Dow Reaching 10,000 is a BIG Deal

My comment on Facebook, 10/14/09: “Woohoo! The Dow is over 10,000. I am glad I did not panic and abandon stocks like many others did when they did not like how their 200.5(k)'s tanked! (For the non-mathematically inclined, a 200.5(k) is your old 401(k) that was only worth half as much as it did before.)”

My primary election opponent’s comment: “WHOOP DE DO! 10K is just another number. So the market is up more than 60% from the March low. It is STILL about 30% below where it was a year and a half ago. I am more concerned with the policies at the national level, the monetarizing of the national debt, and the consequent inevitable inflation reducing the significance of any benchmark.

My follow-up: “The performance of the stock market as indexed by the Dow is much more than WHOOP DE DO!

First of all, although 10,000 may be looked at as “just another number”, it is also perceived as an important psychological barrier. Consumer perception, as translated into consumer confidence, is critical. Despite the fanciest econometric forecasting models economists create, varying levels of consumer confidence and other market psychological impacts create uncertainties that are often totally unpredictable. However, improved consumer confidence is expected to be a necessary component of a recovering economy. Personal consumption (which includes consumer spending AND government health care spending), at 70 percent, was the largest component of GDP in 2006. (The gross domestic product (GDP) is the generally accepted measure of the size of the national economy. It is the sum of investment, personal consumption, government spending, and net exports. Other components of GDP include Investment at 17%, Government spending at 19% and Net exports at minus 6%.)

“One year after a U.S. economy said to be overly dependent upon consumer spending toppled into crisis, consumption now makes up an even larger share of national output.

Personal spending on cars, clothes, food and other items accounts for 71% of gross domestic product, according to the latest Bureau of Economic Analysis data. That's slightly above the level one year ago and well above the long-term average around 65%. . . .

Now, with credit tight, wages flat-lining and unemployment steadily ticking higher, consumers are strapped. Personal spending in the second quarter was $195 billion below the figure for the same period last year. That 1.9% drop is significant — over the 20 years that ended in 2006, consumer spending reliably increased at an annual 3.3% rate.

But other parts of the economy, such as construction and businesses' spending on new equipment, shrank even faster since mid-2008. "Other components of GDP just got crushed," . . . .” http://www.usatoday.com/money/economy/2009-10-11-consumer-spending_N.htm

The bottom line is that until consumer confidence returns and consumer spending picks up, the economy cannot be expected to pick up significantly as businesses are not likely to increase production and increase their inventories until consumers resume their buying. Now, we cannot expect consumer spending to return to the recent heyday when people regarded their homes as their personal ATM machines to support unsustainable spending, Nonetheless, reasonable consumer spending is certainly much greater than the current hunkering down most people are doing, even those with plenty of money to spend.

The Dow hitting 10,000 also has another, very important effect – the wealth effect. As people perceive they are wealthier, they spend more. While 10,000 is well off the Dow high of 14,164.53 on October 9, 2007, it surely is a lot better than the recent low of 6,547 on March 9, 2009. This increase in perceived wealth from just 7 months ago will have an impact on consumer spending, if the Dow level can be maintained long enough to restore confidence.

You are right to be concerned with potential inflation caused by the massive monetization of the Federal budget deficits and other expansionary efforts of the Federal Reserve Board. So far, we have not seen the inflationary effects of the increased money supply because the “velocity” of money has dropped precipitously. (Nominal gross domestic product = money supply x velocity.) Velocity is the turnover rate, or speed that people holding money spend or invest it. As consumer and investor confidence returns, the velocity will pick up, increasing inflation pressures. As long as there is ample underutilized capacity in the economy (unemployed labor, closed or underutilized factories), little inflation is likely, as the result in the short run will be increased production.

Ultimately, however, the Fed will need to reel in the massive increase in the money supply to avoid inflation through unwinding its opening of the auction windows and its open market operations. Whether it will do so at the right time, is questionable. The Fed will be walking the fine line of wanting to bring the money supply into line to prevent inflation while not doing so too soon and squelching the economic recovery. Political pressures will be to delay until clear signs of recovery are seen, and with the lag in the effect on the economy of Fed actions, that will likely result in at least some inflation.

So, the Dow at 10,000 is a big deal, not only for the economy as a whole, but also, I like the way my portfolio looks today a lot better than I did on March 9, 2009.

Comments?