Much has been made of the fact that the Dow Jones Industrial Average hit 11,000 last week. (For further reference, it’s trading at about 11,123 as I type this.) Woooooo?
See, the problem is that I’m not exactly sure what I am supposed to be taking from this information from an overall economic perspective. (Granted, I suppose I am slightly less broke than I was last week, but it’s not exactly like I won the lottery here.) Apparently the guys over at Open Economics agree with me:
(Sidenote: I do see homeless people around Cambridge with laptops, and I think it’s awesome. I will, however, be pissed when the homeless people get iPads before I do.)
Let’s see…I can think back to my finance classes, which told me that stock prices reflect the present value of expected future dividend streams…which would make perfect sense if the market worked that way, but it often doesn’t. I could listen to company CEOs, who all say that strong stock prices are a number one priority…but most of them have a significant portion of their wealth in the stock of their companies, so of course the stock price is a top priority for them. So I am still searching in vain for the significance of the Dow 11,000…
In case you aren’t aware, the stock market is almost purely a secondary market. You can think of it as analogous to the market for baseball cards- prices for baseball cards go up and down, usually in line with a player’s performance in some way, and people buy and sell these cards, but it’s not like a player actually sees a financial benefit from his cards being worth more. (In fact, the causality often goes in the other direction, since the cards are worth more BECAUSE the player is a highly-paid star.) Similarly, stocks of companies go up and down, but it’s not like an increase in stock price actually gives the company more dollars to invest in its business or anything. The only time that the company gets a direct inflow of money in exchange for it’s stock are when it issues new stock, either in the form of an Initial Public Offering (or IPO…we all heard that term being thrown around a lot 10-15 years ago) or an additional offering of new shares of stock. (I suppose that popular baseball players could have additional cards made and then benefit financially from selling them, but a. I’m pretty sure that MLB doesn’t allow this, and b. That would be pretty creepy.)
So, to continue the analogy, saying that the Dow hit 11,000 is like saying that the collective value of baseball cards has reached a certain benchmark…hence my lack of excitement above. (There is a difference with the stock market in that stocks pay dividends whereas baseball cards do not, so at least in the stock market case that people are seeing companies as healthy enough to revise their expectations of future dividends…but this still isn’t enough to make me want to do a little dance or anything.) The point that the cartoon is making is exactly this- that the stock market doing well doesn’t directly create new jobs or drive business investment, since the companies don’t actually see windfalls from their stocks increasing in value.
So why should we care? (No, the answer is not “because Jim Cramer said so.”) In general, the level of the stock market (or whatever specific index you choose to look at) gives a measure of confidence in the future profitability of the companies involved. Given that I often point out that economic booms and busts can become self-fulfilling prophecies- if people think times are bad, they hunker down and sit on their money, but if no one is buying stuff then we do actually experience bad times, and vice versa- the level of the stock market is somewhat important in not only being a signal but also being a driver of consumer confidence. Put simply, if people think that the Dow hitting 11,000 is good for the economy and act in accordance with that, then the Dow hitting 11,000 actually is good for the economy. If this is the way things work, then I will do my part to stimulate the economy: WOOOOOOO!!! HAPPY DANCES ALL AROUND!!!!
Hmm…you’re probably not entirely convinced. Apparently other people aren’t either, since the Dow reached 11,000 with surprisingly low trading volume, which means that the upswing likely isn’t representative of a large base of people having a rosy outlook on the market and the economy. In that case, here’s hoping that all of the happy dances work to convince people that they should go out and buy those new iPads…just, as I said, not the homeless people, since that just makes me feel bad about my own consumption patterns.