Dow At 10,000: The Wall Street-Main Street Disconnect

Many people are cheering the fact that the Dow Jones Industrials Average has reached an apparently signficant milestone - 10,000 - and are suggesting that it means good news for Main Street.

Yet even during more “normal” times, the relationship between the stock market and the economy has been rather tenuous, at least in the short run. Think back to the feeding frenzy that was occurring just over two years ago, when clueless traders pushed equity prices to all-time highs as the financial world and the real economy were undoubtedly falling apart.

Generally speaking, share prices can be influenced by any number of factors, not least of which is the mood of traders - what some refer to as “animal spirits” - and the amount of cash that is available for speculation - er, investment. Conditions on Main Street don’t always enter into it.

In the end, of course, if the fundamental reality fails to match or catch up with the exuberance of the trading crowd, then that sets the stage for a “recalibration”of some sort, which can be swift and violent if the differential has reached unusual extremes.

Is that where we are now? If you read the following sampling of commentaries discussing what I would describe as the Wall Street-Main Street disconnect, I think you’ll find that the answer jumps right out at you:

“Why The 10,000 Point Dow Doesn’t Matter” (Bill George’s Blog)

The Dow is at 10,000.  Reporters glow.  Retirees relax.  Investors sigh: “Whew, we’ve made it.”

They’re wrong.  This purported milestone isn’t a victory.  It’s nonsense.

The market is the wrong place to look when measuring the health of our economy.  The collective wisdom of mutual fund analysts was wrong in 1999, wrong in 2006, and it’s wrong right now.

The best investor in the United States basically ignores Wall Street.  Warren Buffett has billions he could trade in and out of stocks.  Thousands of analysts would clamor to give him hot tips.  But Buffett ignores it all.  Serene, he sits in his office, reading annual reports, newspapers, and thinking about opportunities for growth.  He isn’t drinking champagne tonight.  And you shouldn’t be either.

We are far from out of the woods.  Large companies are still laying off employees.  When we cross the 10% unemployment line, consumer spending (now down to 70% of GDP) may contract even further.  It probably should.  Consumer spending in the UK is 65% and in China it’s only 40%.

Haven’t we learned something from this crisis??  Wall Street sold the world worthless securities, trillions of dollars of wealth evaporated, and now Wall Street is cheering this “new” bull market.  Now the bulls say it’s all okay again?!

What you’re watching now is a bull market on government spending.  What you should be watching is the real report card:

• Inflation: There is $50T in unfunded liabilities on the country’s balance sheet. If the USA played by corporate America’s accounting rules, we’d be bankrupt. The laws of gravity still apply. We will experience significant inflation within 3 years.
• Job Growth: Since the start of the recession in December 2007, we’ve lost 7.6 million jobs. Millions more have stopped looking for work. The analysts keep saying this downward trend will stop. But it hasn’t.
• Innovation: The credit contraction makes it harder for entrepreneurs and small businesses to invest in growth. This segment of the economy is where a rebound will start. Don’t watch the Dow, watch small business credit (contracting) and patents filed (contracting).
• Education: The important word in “Gross Domestic Product” is product. We must have highly skilled knowledge workers to compete against other economic innovators. A third of high school students aren’t graduating. This is the HR pipeline??

Yes, we have stepped back from the abyss.  But some very smart people thought the same thing in 1932.  Then 1933 happened.  Not so fast, Wall Street…

This battle is far from over.  Let’s dig deep, focus on the long haul, and make the substantive policy and business improvements the economy needs to really rebuild.  Then, the Dow will take care of itself.

“Art Cashin: How Today’s Market Is Like Dot-Com Bubble” (CNBC Stock Blog)

The stock rally could have legs after a line of better-than-expected third-quarter earnings reports, but Art Cashin, head of floor operations at UBS, said he isn’t yet convinced.

“The banquet looks stupendous, I hear the wine is great,” he said. “You guys can party on, but some of us are going to sit on the sideline like wallflowers.”

Cashin said he doesn’t think the economy is moving as much as data shows, and he’s worried there are billions of dollars in excess reserves from people not borrowing.

He added that although it’s difficult to compare today’s environment with any other time in history, it reminds him of the dot-com bubble, when people refused to believe the markets would go anywhere but up.

“I said, ‘I’ve never heard of a tree growing straight to Heaven except in Jack in the Beanstalk and that was a fairy tale,’” he said. “And unfortunately [the bubble] turned out to be that way.”

“Don’t Trust Dow 10,000″ (CNNMoney.com)

The stock market is supposed to be a leading indicator, predicting what happens next. But the rally doesn’t mean the nation’s economic woes are over.

As the Dow closed above 10,000 for the first time in more than a year Wednesday, economists cautioned that the blue-chip average shouldn’t be seen as giving a green light to the economy.

The stock market is what is known as a leading economic indicator, as investors place bets on how strong they believe company results and the broader economy will be in the near future.

Lately, there has been a growing consensus among both investors and economists that the battered U.S. economy hit bottom and turned around earlier this year, and is now in a recovery.

The Federal Reserve said economic activity has “picked up” in its statement after its Sept. 23 meeting, and about 80% of leading economists surveyed by the National Association for Business Economics agreed in a survey earlier this month that the recovery has begun.

But even economists who agree the economy is in recovery say that growth will be slow and difficult, with continued job losses, tight credit and further declines in home prices. And even some who believe that the current Dow 10,000 level is justified say there’s still a significant risk that the economy will take a step backward.

“One of the great challenges is whether consumers and small businesses come along with this recovery,” said John Silvia, chief economist with Wells Fargo. “If they don’t, you either sit at 10,000 or slip back to 9,500. To sustain another double-digit (percentage) gain to Dow 11,000 is asking too much from this economy and the risks we still see out there.”

There are also economists who question whether the economy is truly in recovery, given that it continues to lose about a quarter-million jobs a month. They say the more than 50% rally in the Dow since it closed at a low of 6,594.44 on March 5 is only a reflection that the fear of the economy toppling into a full-fledged depression has abated.

“We’re not at Armageddon anymore, so of course you should have some kind of rally,” said Rich Yamarone, director of economic research at Argus Research. “But I think there’s a bubble-like atmosphere going on here in the rush back to 10,000. Caution should rule the day. We’re not out of the woods yet.”

Several experts point out than many of the relatively strong earnings reports helping to lift the markets in recent days are being driven by cost cuts, rather than strong revenue growth that would be a better indicator of consumers and businesses being willing to spend again. If businesses keep cutting costs to make the numbers that Wall Street wants to see, that can only put more downward pressure on jobs and wages, and result in weaker economic growth or another downturn.

“The companies are cutting fat, and in many cases cutting bone and muscle. There’s no organic economic growth there,” said Yamarone.

Barry Ritholtz, CEO and director of equity research at Fusion IQ, said that despite their reputation as a leading indicator, the stock markets do a terrible job forecasting the economy.

“Beware of economists pointing to the stock market,” he said. “The rallies tend to be false starts because it’s a reaction to what came before. The sell-offs tend to be overdone because, as they gain momentum, they lead to panics.”

Ritholtz said comparisons of current earnings to those of a year ago or stock levels to the lows of earlier this year greatly exaggerate the strength even the market sees in the economic outlook.

“It’s like saying the Detroit Lions have better year-over-year comparisons because they’re no longer winless,” he said about the football team that went 0-16 in 2008, but has won one of five games so far this year. “But they’re still in last place and they’re not winning the Super Bowl.”

Another reason that comparisons to Dow levels of a year ago are risky is that two of the more troubled components — General Motors and Citigroup (C, Fortune 500) — were dropped and replaced by stronger companies such as Cisco Systems (CSCO, Fortune 500) and Travelers Cos. (TRV, Fortune 500) in June.

Without those changes the Dow would be almost 100 points lower now than it is with the stronger companies, although precise comparisons are difficult since GM shares are no longer traded on the New York Stock Exchange.

“You take out the worst, put in the best, and by definition you’ll get better numbers,” said Yamarone.

“Why the Dow Broke 10,000, and Why You Should Still Watch Your Wallet” (Robert Reich’s blog)

How did the Dow break 10,000 when the rest of the economy is in the toilet?

1. Corporate earnings are up — mainly because companies have been cutting costs. Payrolls comprise 70 percent of most companies’ costs, which means companies have been slashing jobs. In the end, this is a self-defeating strategy. If workers don’t have jobs or are afraid of losing them, they won’t buy, and company profits will disappear.

2. Federal borrowing has filled the gap that consumers and businesses created when the latter began to reduce their debt. Federal debt, in other words, has kept the economy from tanking. Can’t keep up forever, though.

3. With such horrid employment numbers, Wall Street figures the Fed will keep interest rates low for some time, and continue to flood the economy with money. That’s good news for the Street because it means money stays cheap — and with cheap money the Street can make lots of bets on almost everything under the sun and moon. As a result, the Street’s earnings are way up. But this, too, is temporary. At some point the Fed is going to worry about inflation and a falling dollar.

4. Investors of all stripes want to get in early and ride the wave. Pension funds, mutual funds, and other institutional investors figure the bull market has more oomph in it because, well, other investors will jump in. Think Ponzi scheme. Nice for now, but watch out if you’re one of the last in.

In other words, this is all temporary fluff, folks. Anyone who hasn’t learned by now that there’s almost no relationship between the Dow and the real economy deserves to lose his or her shirt in the Wall Street casino.

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