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Analysis/Comment Last Updated: Mar 7, 2013 - 8:12 AM

Dr. Peter Morici: As Dow sets record, stronger growth needed to sustain bull market
By Professor Peter Morici
Mar 7, 2013 - 5:08 AM

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The New York Stock Exchange, Wall Street, New York.

John Authers in The Financial Times fired a broadside on Wednesday saying that as an index of only 30 stocks, "the Dow is not broadly diversified and is not representative of the US stock market as a whole (the S&P 500, the world’s most widely followed index, is better for that purpose). Its stocks are not uniformly large enough to qualify as a “mega-cap” index, varying from Alcoa ($9bn) to ExxonMobil ($399bn).

Crucially, the Dow’s illogically chosen members are weighted by their share price, rather than their market valuation. This means companies that happen to have a high share price can outweigh larger companies with a smaller price per share. This is ludicrous. For example. IBM now accounts for 11.1% of the Dow and has a market value of $228.7bn. Apple has never been a Dow member and ExxonMobil has a market cap of $398.5bn, but a Dow weighting of only 4.8%. Microsoft, a slightly larger company than IBM these days at $235.8bn, accounts for only 1.5% of the Dow. Meanwhile, Caterpillar outweighs both ExxonMobil and Microsoft, despite having a market value of only $58.8bn."

Finfacts Dow Jones Milestones since 1896

Dr. Peter Morici: With the Dow Jones Industrial Average setting new records, it is important to recognize current stock prices are hardly extraordinary. Adjusted for inflation, stocks are still well below their January 2000 peak and may have a long way yet to run, but much stronger economic growth is needed to drive profits higher and sustain a bull market.

Stock prices are helped by the Federal Reserve’s bond buying and thumb on interest rates, and by cash rich companies aggressively buying back stocks and boosting dividends. Simply, US CEOs are flush with cash but don’t have enough opportunities to invest in organic growth in a slow growing US economy.

To date, corporate profits have been driven higher mostly by US firms thinning employee ranks to accommodate slow growing domestic sales, and by big gains abroad—about half of the profits of S&P 500 companies are earned outside the United States.

Boosting worker productivity in slow growing markets has limits, and many companies may reach those in 2013. Repatriated foreign profits face stiff corporate taxes making future stock buy backs and boosting dividends more difficult.

In the end, a stronger US economy is needed to sustain a bull market into 2014, and the fundamental competitiveness of the US economy in global markets must be improved.

Consumer spending should strengthen with improvements in the housing market; however, reductions in federal spending and deficits and eventual Fed pull back from bond buying and higher mortgage rates policy portends only moderate growth in the combined contributions to aggregate demand from consumers, federal and state governments, and residential construction—those ultimately drive the remaining component of demand, business investments in structures, equipment, software and the like. 

Too many consumer dollars go abroad for Middle East oil and Chinese goods that do not return to buy US exports. Thursday, the Commerce Department is expected to report the January deficit on international trade in goods and services was $43bn—about $500bn annually.

Businesses, consequently, are pessimistic about future demand for US-made goods and services. And bearing higher taxes, more burdensome regulations, and increased benefits costs mandated by Obama Care, they are reluctant to undertake major new investments in the United States and continue investing and hiring mostly abroad. 

Imported oil and subsidized imports from China account for the entire trade gap. Development of new onshore reserves in the Lower 48, despite all the hype, have not delivered nearly enough new oil, and a full push on US potential in the Gulf, off the Atlantic and Pacific coasts and in Alaska could cut US imports in half, push US growth well above three percent a year, and persistently push up US stock prices.

The surge in natural gas production and accompanying lower prices substantially improves the international competitiveness of industries like petrochemicals, fertilizers, plastics, and primary metals—and important new investments have been announced. Investment opportunities are beginning to surface to deploy natural gas in place of oil in rail and coastal water transportation. 

However, the Energy Department of Energy is reviewing licenses to boost exports of liquefied gas that would reduce the trade deficit and boost domestic demand, economic growth and corporate profits earned in the Unite States much less, than keeping the gas at home to boost energy-intensive manufacturing and alternatives to gasoline in transportation.

To keep Chinese products artificially inexpensive on US store shelves, Beijing undervalues the yuan through official intervention in currency markets and actions of state owned banks, which often evade calibration in their scope. Other Asian governments pursue similar strategies to stay competitive with the Middle Kingdom.

Economists across the ideological and political spectrum have offered strategies to offset the negative consequences of these mercantilist policies but the Obama Administration has refused to even acknowledge those options.
Cutting the trade deficit by $250bn, through better domestic energy and trade policies, would ignite growth in the range of 5 percent a year—comparable to the economic recovery of the Reagan years—and fuel a bull market that would last until the end of the decade and take the Dow past 20,000.

Peter Morici,

Professor, Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742-1815,

703 549 4338 Phone

703 618 4338 Cell Phone




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