Dow Delusions

The most watched stock market index on the planet, the Dow Jones Industrial Average (the Dow) hit a record closing high on Tuesday this week, surpassing the previous high of 14198 set on the 11th October 2007, as can be seen within the first chart below.


Needless to say there has been a fair amount of coverage about this momentous market event, which included an article on the Dow in “inflation adjusted terms,” suggesting that inflation had eroded half of the Dow’s gain since 1994

It’s a very valid point, in that investors’ should look a the “real return,” of any long term investment decision made or being considered, but we are not so sure that the correct comparison should be the “official measure of inflation, the consumer price index, or CPI.”

The latest reading of US CPI is stated at 1.6% pa, but does anyone, aside of government statisticians, actually believe that number? Anyone who actually fills up their tank, rents a home (40 % of the US inflation basket is related to the cost of renting,) or assists their kids with education costs can only dream that their cost of living is only advancing by 1.6% per year

If one really wishes to look at inflation, including the cause of it, you only have to look at a measure of “credit growth,” but this is a subject for another day,  for now, let us look at Dow in nominal terms, as shown above, when compared with the Dow in CPI terms.

Quite where the “A N Other” article derived their CPI data from we are not sure, but data obtained from our Bloomberg terminal produces the following comparison.




Yes, there has been a lag for the Dow, in CPI adjusted terms (the blue dashed line) but not by a lot. It currently equates to a Dow level of 12450, only 13% below last night’s close of 14329 for the nominal Dow. Those aside, please note the slavish correlation between the nominal Dow and the “inflation adjusted Dow,” over the long term bull market since 1982, whether during bull or bear phases of it.

Surely it would make more sense to compare the nominal Dow to a basket of goods that we all actually use on a daily basis, such as energy and agricultural foods, plus metals such as copper, used extensively within the construction and industrial sectors. Such a basket exists and it’s called the Continuous Commodities Index, or CCI.

Adding this to our earlier comparison, shown in red, throws up some interesting changes and observations.




  • The correlation  mentioned earlier between the nominal and inflation adjusted Dow remains  and extends also to the commodity adjusted Dow, which we will call the Real Dow, but its  all time high was actually in 1999, 14 years ago, since when it has      collapsed by 55% .
  • The nominal and the real Dow continued their  correlation post the “tech smash” of 2000 -2003, but in 2003 something      changed, there has been a major divergence.

We suggest that the difference is down to the “ illusion of credit ” as the use of credit by individuals, corporates and government soared. The real Dow shows where the Dow would be without the effects of this increased debt load.

The divergence became even more extreme, post 2007 credit crunch ( notice how nobody uses that term now, whereas 3 years ago the term popped up in just about every news item) as policymakers commenced their $US Trillion stimulus binge.

The $US 64,000,000,000,000 question now, of course, is can the credit growth continue to push the Dow higher? Or, is the illusion about to change to delusion, with the nominal Dow re-aligning with its real cousin, some 60% below its recent record high?


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