Oscar Wilde once said that â€œa cynic knows the price of everything and the value of nothing.â€ Perhaps that quote could be justly applied to most promoters in todayâ€™s financial media.
Those who follow the stock market are aware by now that the Dow Jones Industrial average hit a new all-time high last week, closing in on the 13,000 mark. And to promoters of the stock market, this is big news. Stocks have never been worth more, they say!
And, they continue, doesnâ€™t this new high provide even more evidence of the value of investing in stocks? Of course, weâ€™ll hear the â€œstocks for the long runâ€ argument return, since losses incurred by investors during the bear market cycle from 2000 to 2002 have now been recouped. Right?
Not so fast!
Looking again at the quote from Oscar Wilde, could it be that cynics like me are not the only folks who know the price of everything and the value of nothing? Might that group also include those who make a living touting stocks and mutual funds? Letâ€™s take a look at some interesting data.
Sure, the price of the Dow average is now close to 13,000. But what is the purchasing power of the money you would get after cashing out of your investment portfolio? Look to the south, to places like Venezuela and Peru, whose stock markets soared higher last year, both up over 100% for the year. In Venezuela, investors needed strong growth in their savings, since the value of the currency was falling fast.
Inflation in Venezuela has been running close to 20% a year for the past six years, and that amount is a reduction from much higher inflation rates in previous decades. But some solid investigative work done by John Williams (of the shadowstats.com web site) shows that inflation in the U.S. is closer to 10% than to estimates provided by official government figures.
Of course, anyone can argue that either number is closer to reality, depending on which calculation methodology is used. But letâ€™s take a look at some other widely accepted measures of inflation. For example, what will a dollar buy today compared to what it would have bought in the year 2000?
Letâ€™s use the exchange-traded fund DIA as a tool for pricing Dow shares at the start of 2000, when those shares sold for about $110. They now sell for about $129. So in the past seven years, the value of that fund has risen by about 17%. Not bad, right? Hold on a minute!
That amount works out to an average annual return of about 2.23%. The problem with that, if Williams proves correct, is the rise in inflation over that same time period. And, of course, we should never accept just one data point to make our case. We should, instead look at a group of data points in our search for validation. So letâ€™s peruse another excellent analysis posted on the web site www.goldsilver.com and written by Mike Maloney. The article provides even more insight into the value of those Dow shares, and according to Maloney, the value of the Dow has actually â€œcrashedâ€ in the past seven years. He argues:
â€œThe Dow is actually crashing, but if you have not yet educated yourself on the insidious ravages that inflation can have on your portfolio, you canâ€™t see it. This is a blind spot investors must be mindful of, and guard against, if they are to prosper.
â€œAnytime that it looks like everything is going up, stocks, bonds, real estate, commodities, and virtually every kind of investment there is, you have to stop and ask yourself, â€˜why?â€™
â€œThe only reason the Dow looks like it is going up is because the Fed has pumped so many more dollars into the currency supply, that all asset classes are rising. Under these conditions, the only way to see where true value lies is to eliminate the dollar from the equationâ€¦ you have to measure each asset class, not with the dollar, but against another asset class.â€™â€™
Maloney has provided some charts to illustrate his points. In one chart, he shows how the value of the U.S. Dollar Index has been hammered since the summer of 2002, falling from about 120 to the present 82. So if the value of the dollar, when compared to foreign currencies, has fallen over 30%, what is the value of todayâ€™s Dow compared to 2002, when it is cashed out for dollars whose value has fallen that much?
Continuing his comparisons, Maloney also uses the price of gold, which is historically used as a benchmark for inflation, to measure the true value of the Dow.
â€œIn this chart I measure the Dow with money, not currency. It took almost 45 ounces of gold to buy 1 share of the Dow in 1999. Today it takes less than 19. Another way of saying it, if you sold 1 share of the Dow in 1999 you would have been able to buy 45 ounces of gold. Today if you sold 1 share of the Dow, the proceeds would only buy you 19 ounces of real money. So measured in real money, the Dow has crashed 58%.â€
Is this still not enough evidence for you believers in the Dow? Well, letâ€™s look at the value of silver, another inflation proxy. A share of the Dow buys 65% less silver than it did in the early part of this decade. At todayâ€™s prices, an investor using Euros to buy shares in the Dow would get back 27% less money when those shares were converted back into that currency. An Aussie investor would lose 30%, and a Brit would realize 22% fewer pounds as the â€œrecoveryâ€ price of his Dow shares. And hereâ€™s another good comparison from Maloney.
â€œHow much oil (our proxy for energy) can you buy with proceeds from the sale of your Dow shares? If you sold 1 share of the Dow in early 1999 you could buy 800 barrels of oilâ€¦ today itâ€™ll only buy you 200.â€
Or how about his next observation?
â€œSpeaking of carsâ€¦ along with plastics, cars are made of metals like steel, zinc, copper, and lead. Measured against the Dow Jones Industrial Metals Spot Price Index, the Dow has crashed by 73%. And believe it or not, this is one of the reasons the companies that make cars have crashed.â€
At this point, Maloney has reviewed only the best-performing of the three major averages used as proxies for the performance of the domestic stock market. Currently, the S&P 500 remains lower than its previous, pre-bear market peak, and the Nasdaq has climbed only half as high as it did previously.
Can you now see the significant damage to the value of stocks, rising in price to new highs? And donâ€™t forget how many of these same financial media promoters were touting technology stocks at their peak, warning us that â€œthe only risk in tech stocks is in not owning themâ€ — and similar nonsense.
Much of the cause for this loss in the dollarâ€™s purchasing power can be attributed to Fed policies and attempts to hide its recklessness over the past few years. Maloney also points out that when the Fed stopped reporting the broadest gauge of the money supply in early 2006, that amount stood at $10.29 trillion.
That figure had jumped sharply from the January 2000 number of about $6.5 trillion. This represents a 58% increase in the money supply, now lovingly called â€œan abundance of liquidityâ€ by stock market Bulls.
If the Fed continues to increase the money supply by almost 8% annually, we can see why inflation must be running much higher than official figures suggest. And when we consider this countryâ€™s trade deficit, Federal budget deficit and looming Social Security and Medicare liabilities, is there any reason to think that the printing presses will slow down anytime soon?
Of course, as Star Trekâ€™s Mr. Spock often said, â€œThere are always alternatives.â€ And this is true for investors. To me, the alternatives include what I have written about in this column for the past several years: invest in those things that are rising fastest against the dollar. This strategy argues strenuously for buying gold, silver, energy and other commodities. It also argues for buying international stocks, whose profits and dividends are paid in their stronger currencies.
Sure, the Dow is now at a new, all-time high. But in terms of value, a million dollars wonâ€™t buy in 2007 what it bought in 2000. So whatâ€™s been gained? And why are the promoters partying like it was 1999 once again?
Hey, they know that â€œif itâ€™s all you got, use it for all its worth.â€ But today, the value is worth much less than it was the last time new highs were seen.
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., firstname.lastname@example.org.