Wednesday, March 13, 2013

DOW vs. Economy

Washington Post - The History of the Dow Jones industrial average

With the stock market roaring to new highs, New York Times reporter Nelson Schwartz asked “why stock markets are thriving even as the economy is barely growing and unemployment remains stubbornly high.” And “While buoyant earnings are rewarded by investors and make American companies more competitive globally, they have not translated into additional jobs at home.”

Great question. To answer it, Schwartz focused on companies’ drive to maintain profit margins, as well as increases in their productivity that enable them to reduce their workforce. Specifically, corporations are supposedly getting rich at the expense of employees.

Diana Furchtgott-Roth, writing for MarketWatch, says it’s not that simple: 
“With the Federal Reserve expanding the money supply and driving down interest rates, markets soar as investors seek riskier assets.  At the same time, a weak dollar slows the economy by discouraging investment and raising prices of commodities, such as gold, oil, and food.”
She added that “One reason that multinationals’ profits are high is that companies are sitting on substantial amounts of cash, much of it overseas.  The Senate Permanent Subcommittee on Investigations has estimated that American companies hold offshore around $1.7 trillion of earnings from foreign operations.  They are keeping these funds offshore because America’s corporate tax rate is one of the highest in the industrialized world. 

Currently, the U.S. corporate tax rate is 35%, compared with an average of 23% for our industrialized competitors in the Organisation for Economic Cooperation and Development.  Plus, America is one of only seven of the 34 OECD countries that taxes companies on its worldwide income, not just income earned in the United States.  This means that if the profits are brought into the United States, companies would lose a large share to Uncle Sam.

In conclusion, Mark Thoma, writing for Moneywatch, had this to say:   
Many analysts expect the U.S. economic recovery to continue, but this prediction has very little to do with asset price movements.  Using the stock market to predict the future of the economy is risky.  For example, the previous peak in the Dow was in October 2007, just two months before the onset of the recession.  That peak certainly didn't indicate that the economy was on solid footing.  
More generally, the relationship between the stock market and the economy is not very reliable and stock market values only explain a small proportion of the total movement in variables like GDP and employment.  Thus, while it's very likely that the recovery will continue at its slow pace, that prediction has little to do with recent movements in stock prices.