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Markets Reach New Highs! It Doesn’t Matter!

Businessman Bouncing Over Stock ChartEventually, sooner rather than later, newspaper headlines will trumpet a new record high for the Dow Jones Industrial Averages and the S&P 500 index.  At 14,029, the Dow is just a 1% rise from its record closing high of 14,164.53 set on October 9, 2007, and the S&P large cap index, at 1,511.76, is not far from its record of 1,565 set on the same day.

But these records are really meaningless to investment professionals and people who make a living giving investment advice.  Why?  Because the record really isn’t the record in real terms.

Come again?  Index milestones don’t take into account several factors.  Like dividends.  Barron’s has reported that the past year’s dividends on the Dow have added the equivalent of almost 350 points to the average, and the previous year, that figure was 320 points.  On a total return basis, investors in the Dow or the S&P 500 have already see their asset levels reach record highs.

However, this picture is also complicated by inflation.  Even if the levels of the index are the same on two different dates, the actual purchasing power of the money invested in the index will be lower on the second date.  By how much?  Since October of 2007, the Consumer Price Index has risen by about 10%.  That would suggest that the Dow would need to reach 15,500 to set a new record level, adjusted for inflation.  The S&P 500 would have to reach 1,700 before it was in record territory on a real, after-inflation basis.

What does this mean?  It means that the daily market movements, and especially market milestones, should generally be regarded as entertainment rather than real news.  In the short term, market movements are a reflection of the mood of the moment–do investors feel good or bad about the future, and about stocks?  In the long term, the underlying trend is usually positive, as companies gradually, through the daily efforts of their workers and the decisions of their managers, become more profitable and more valuable to their stock investors.

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