The Paradox of the Dow Jones at 13.000

On 28 February, 2012, the Dow Jones industrial average closed above 13,000 for the first time since December 2007. Considering the amount of crisis talk going, it is fair to ask how this is at all possible.

There are three major and two minor reasons for this impressive run. 

1. The first is the willingness and desperation of policymakers to artificially secure cheap money forever.
2. The second is quantitative easing. The Jackson Hole 2009 announcement about QE took the Dow from 9,500 to 12,800 by last spring, then the market sold off on the EU debt crisis, only to see a massive expansion of the ECB balance sheet - up 38 percent before today’s second Long-Term Refinancing Operation (LTRO-2). Hence, a lot of the strength has come from easing policy and the firm belief among policymakers that by buying time through low interest rates the economy will heal itself.
3. The third important reason has been the ability of companies to positively adapt their operations and businesses to world growth cycles. Many companies have done an excellent job at this and have seen higher margins and earnings as a result.

Finally, the two minor reasons: 

1. First of all, the Dow Jones has less of a financial weighting in its index than the S&P-500.
2. Secondly, in terms of individual stocks there are only 30 stocks in the Dow and its performance has been driven by IBM, Intel and Microsoft, plus McDonalds’ and Wall-Mart. They are all conservative, well-managed companies which are notoriously defensive by nature, so overall the mix of IT plus defensive stocks can cyclically explain the outperformance of the Dow versus other more broad indexes.

The key point to this being: How real is the theory of low interest rates creating a process of self-healing economies?

This is not happening particularly if you look at how employment and fiscal deficits are developing. Secondly, there is good reason to argue that Earnings Per Share growth has peaked. There are still companies which are in great shape but the economic reality (even for expanding companies too) is one full of spending constraints from with customers (both corporate and private) and certainly less disposable income all around. Stocks tend to perform well in early phases of easing and not so well when money becomes more market-driven.

Nevertheless, I have to tip my hat for how well corporate America has dealt with this crisis. Perhaps this could be the start of the US once again becoming a growth engine for the world, replacing emerging countries.