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.
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