So often we gauge the health of the US economy based on the Dow Jones Industrial Average (DJIA). Why? Probably because it’s a financial number that reporters can easily find and track, and somehow we’ve equated the stock market to economic health. Stop it.
First off… what the heck is the DJIA? It’s an index that tracks the value of 30 of the biggest stocks traded in the US. That’s right, we meticulously track 30 stocks to tell us about how everything is going. Now, to be fair, these stocks represent the biggest companies in the most important sectors, so it’s an indicator of economic health, but it can be grossly deceiving.
In situations where these so-called “blue chip” stocks would thrive, the DJIA will be deceptively high. These situations might include increased globalization, higher government spending, and poor situations for small company (i.e. potential competitor) growth. Furthermore, just about all of the 30 companies do a significant portion of their business, production or sales) in other countries, not just the US. Growth in other parts of the world are factored in. Now, I’m not saying that the DJIA isn’t useful at all. It gives us some information on the direction investors believe the economy is about to go in. The problem is that there are so many other better indicators, yet pundits go to this crutch over and over.
Take a look at the graph below. One axis has the growth in US GDP and the other has the DJIA level. One thing to note is that the Dow plummeted by the end of 2008, but the economy didn’t bottom out until 2009. Not bad. However, look at the Dow’s reaction to the economic boom of the early 90s. The Dow doesn’t start its rise until 1994, but the economic growth was strong throughout 1992 and 1993. The Dow also got hit hard in 2002. The economy was actually on the rebound at that point. The takeaway here is that movements in the Dow might mean something about the current/future economy as a whole and they might not.
The DJIA is highly overrated as an indicator of how things are going in the US economy. If you really need a quick indicator based off the markets, at least go with the S&P500 (I’ll let you guess how many stocks are in that one). Better indicators, though, don’t come day-by-day. Jobs reports, GDP growth, etc. Don’t take the bait when someone points to the DJIA as a rebuttal to unemployment figures. The things that really affect us day by day are not to be found on the ticker. Unless you have a huge stock portfolio… then congrats I guess.