The Real DOW is at 8,800 Right Now


What I have to say today might shock you. But by all historical valuation metrics, the Dow Jones Industrial Index is worth 8,800.

Taking in the recent close of 13,458, that means the Dow Jones is overvalued by 53%.

Let me explain how I arrived at that unsettling conclusion.

Primarily, it's because historically the Dow has risen pretty closely in tandem with nominal Gross Domestic Product.

That makes sense, because corporate profits in the long run have to track GDP fairly closely, and stocks can't soar forever if profits don't follow.

In fact, from 1917 to 1994, the stocks vs. GDP metric practically matched, with periods of overvaluation in the 1920s and 1960s, and periods of undervaluation in the 1930s and late 1970s.

In short, the correlation was nearly perfect for 77 years-until it wasn't.

For this you can thank Alan Greenspan, the erstwhile "Maestro."

The Greenspan Fed Changed the Game

On February 23, 1995 then-Fed chairman Alan Greenspan, in his semi-annual Humphrey-Hawkins Act testimony to Congress, announced that he was ending his period of money tightening that had taken the federal funds rate up to 6% and would start letting rates decline.

Spurred by this news, the Dow Jones Industrial index that afternoon touched 4,000 for the first time.

But at 4,000, the Dow was not undervalued. Loosening the money supply wasn't necessary.

After all, it had peaked at 2,722 only seven years earlier and had then suffered a decline of 1,000 points in a few weeks, including the notorious "Black Monday" crash. At 4,000 it had gone well beyond what in 1987 appeared an unsustainable high, and appeared fairly fully valued.

Of course, Greenspan's Senate testimony did not appear important at first – the Fed had raised and lowered interest rates many times before.

But on this occasion, thanks to more cheap money, the stock market took off.

Within less than two years, by December 1996, the Dow had hit 6,400. Not long after, Greenspan gave his famous "irrational exuberance" speech.

However Greenspan did nothing about what he thought was a dangerously overvalued market, and money supply increased at around 10% per annum between 1995 and 2000.

The result was a spectacular stock market boom unequalled in world history. Irrational exuberance went into overdrive.

So much so that by 2000, I expected the stock market to revert to its 1995 level, which with the increase in nominal GDP in 1995-2000 was equivalent to about 5,500.

However, Greenspan did not want that to happen and, unlike me, he was Chairman of the Fed.

So he cut interest rates savagely, creating a massive housing bubble in the process.

And then when the housing bubble caused the banking crash in 2008, Greenspan's successor, Ben Bernanke, cut interest rates all the way to zero. We've been there ever since. Meanwhile, Bernanke has promised to keep rates at zero into 2015.

As a result, we've had very low interest rates and a very rapid growth in the money supply ever since 1995. The problem is all of this occurred far faster than GDP growth, even including inflation.

Thanks to monetary policy, the train had jumped the tracks.

The Math Behind Dow 8,800

So while GDP has grown steadily since 1995, the cheap money gains in the stock market became bloated and outsized.

Here's why…

Including inflation, nominal GDP has grown about 120% since February 1995. Meanwhile the stock market managed to climb by a whopping 245%!

So if it had matched GDP, as it had ever since 1917, the Real Dow would be standing roughly at 8,800 today.

It only follows that if economic growth continued at its current pace, with say 2% growth and 3% inflation, the "GDP-linked" Dow would catch up to its current level by 2021.

But what about earnings, you say?…

It's true. Normally, you'd expect a Dow that was 50% above its proper level to be abnormally high in terms of both dividends and P/E ratios.

In terms of dividends it is; the Dow Jones index currently yields 2.5%, lower than the 3.2% yield at its peak in 1929. However in terms of earnings the Dow Jones P/E ratio at 14.6 times is just around the long-term historical average.

That's because earnings themselves are in a huge bubble. Indeed, the ratio of corporate earnings to GDP is currently at an all-time high, higher than at its peak in 1929 and much higher than it was in 2000.

There are several reasons for this bubble, such as the profits from outsourcing that large international companies have enjoyed in recent years, but the main cause is low interest rates.

If half a company's balance sheet is debt, then ultra-low interest rates, by reducing the cost of debt, will increase earnings. Needless to say, outsourcing profits can be expected to decline as emerging market wage levels rise, and ultra-low interest rates won't last forever.

That's why expected returns to investors are so low these days-about 6% per annum compared to 9-10% in the 75 years to 2000.

The truth is all the profit from the Dow's rise between 1995 and 2012 was concentrated into the first five years of the 1990s stock market bubble. Since 2000, the real Dow has appreciated only modestly.

Now faced with the prospect of interest rates rising sometime in the future and outsourcing profits that start to decline, the Dow likely won't increase much this side of 2021.

The good news is that this comatose market won't last forever. Once rising GDP has caught up to the Dow around 2021, the market and the economy will once again increase in tandem.

However we should understand – investors don't have to wait that long to start making money again.

Depending on your situation, it's possible to reap anywhere from $1,000 to $10,000 a month in any market-up, down, or even flat.

What's more, you could double that with one little step I detail here.

The point is, you don't have to let this bubble market suck your life savings down the drain.

Otherwise, you'll be in for a quite a long wait before the next real bull market returns.

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  1. Bob Hamrick | September 28, 2012

    To Martin Hutchinson:
    From the promo for your service:
    "For this entire time, R.R. Donnelly has paid out a large portion of its profits as a yearly dividend of $1.04 a share. Based on today's share price of around $11, this would be a roughly a 9.5% annual return."

    BUT, with REAL inflation ( currently around 5% (and other estimates as high as 14%!!!), and subject to spikes at any time, the net return on this issue (and all similar) is far less than "9.5%", and could actually turn negative (if it hasn't already), depending on any number of adverse developments. The company could cut its dividend; the entire market could drop, taking all equities with it; etc. So why tie up funds in any investment which can only react negatively to such developments?
    [Ex-E.F. Hutton reg rep.]

  2. Forrest W Byers | September 28, 2012

    . There are several things that I wonder about, I read elsewhere, that central banks around the world , while increasing the supply of Fiat currency in the respective nations, have also been buying ever-increasing amounts of real stuff i.e. gold. So what exactly is the result of these two counter cyclical trends ?If Barack Obama will wins a second term with his Keynesian – Marxist economic insistence, it seems quite clear, that we are headed for major economic destruction of the United States, which will also mean in coordination with other central-bank idiocies around the world, major global depression. On the other hand, if we have A New President in Mitt Romney, which will be a sort of Ronald Reagan light, we can anticipate the replacement of Ben Bernanke, hopefully to be replaced with a Fed chairman with Austrian school of economics mindset, but that is just hope. The central banks seem to be playing a duplicitous game, giving into a kind of Keynesian approval of money printing while at the same time, increasing their possession of the real stuff, that being gold. This seems to me to be combining fantasy in hopes it will work while pitching your bets in case it does not with the genuine item , with universal recognition that gold is in fact the real money of the world. The ramifications of all this is not exactly clear to me, but gold and precious metals in terms of personal possession strikes me as a no-brainier.

    • dave | September 28, 2012

      ronald regan(R.R.) was not a billionire,.he cared about the top as much as the bottom earners.he clearly stated "why should the bus driver pay a higher %of his pay,than the millionire.i'm sorry to inform you Mr.Romney's belief are not that ofR.R.The 40th president cared about all americans.and let me add i worked construction over 30 yrs.with alot of different crews.i never met anyone that one that said " i hope i get laid off, i'll get food stamps'.all that rhetoric respectivly is b.s.

  3. Dimi Chakalov | September 28, 2012

    Great article; thank you very much. I think there is a huge latent pressure outside the U.S. regarding the rise of inflation there from the fictitious QE3 money, and once they realize that the trend is indeed irreversible, they may dump the USD and crash the bond market. The event that can trigger such crash is the fiscal cliff around April 2013. The party may last just seven months more.

    Any other, possible more optimistic, forecast will be greatly appreciated.

    D. Chakalov

  4. dave | September 28, 2012

    the problems with your theory are we are now in a global economy. and corp america companies balance sheets are headed to the how do you explain these corps wealthy balnace seems to me at 8000 these companies profits ,earnings be about even compared to debt.the next t hing you guys are going to tell us" the sky is fallen" but if you buy my book or white paper .it won't fall on you. like so many other doom and gloom thorist.

  5. MM | September 28, 2012

    Graphs would make your discussion much more visual.

  6. Ric Mauricio | September 28, 2012


    Very interesting calculation. However, comparing the U.S. GDP growth vs. the growth of the Dow is like comparing apples and oranges. The growth in the Dow (companies in the Dow) is due to the fact that they are multinational companies and most of their growth is overseas, where GDP growth is much greater.


  7. EdInvests | September 28, 2012

    I think you are completely ignoring the relationship to profits and unemployment. Companies eliminated marginal products in development, made drastic reductions in headcount, and came out of it with a stronger, leaner, business model. It was long overdue. The few companies in the Dow don't really reflect the overall market anyway. I will happily stay invested and wait out any adjustments while happily ignoring your thoughts.

  8. dourdan | September 28, 2012

    dont everyone burst out of the closet at once

  9. Joe M. | September 28, 2012

    Good article, and it is always good to be diversified. I've taken the view of cyclical risk management. My own theory of course. It means that I look at where we are generally in the cycle and determine how much risk there could be in the next 3 years. I don't have a crystal ball, but like seasons there are some general trends. When the market is reaching for 90% of the previous record high reduce your exposure to stock by 30-40%. Reason being that except for the 1995 bull market, all others reached just a small percentage of 5-30% above previous record high. Missing out on that extra 15% by not being invested in it is a cost. The market collapse of 2008-09 and 2001-03 resulted in as much as 50% loss. Now take the money you have put aside into cash when times are good and reinvest after market correction and you are looking at a significant market return that will put the look of envy on others less savvy then yourself. I took 35% of my balance in 2007 and put it in cash, and reinvested the same in Apr 2009. My 401/IRA recovered to 2007 levels in mid-2010. How about yours?

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