Wow, that Dow! Ten thou now?

While our economy swirls down to third world levels, the U.S. economy continues to paint the term “global dominance” in red, white and blue. If you’ve spent the past couple of years watching your fortunes ebb here, only to see the U.S. stock market skyrocket, you’re not alone. Our buddies in the states are laughing at us now…laughing all the way to the bank.

And there’s plenty to be banked. The Dow Jones Industrial Average, the most popular index of stock prices, hit a new high Friday, at 9,731. Yesterday it eased a bit–just 8.5 points–and the question everyone’s asking: Will it hit the big ten thou mark?
Ten thou–what a heady number. I’m too young to remember when the Dow passed the 1,000 mark in 1972. After that, it took until late 1985 to hit the 1,500 level. At that time a few soothsayers said the Dow would pass the 3,000 mark in the near future, and I dismissed them as grandstanding dingbats. Oops.

What’s fueled this share price rocket ride? Three main factors. First, of course, is the strong growth in the U.S. economy. Such growth brings more wealth into corporations, making their shares more valuable. And the continued expectations of growth result in expectations for more rises in corporate profits. Result: higher share prices.

The second factor is blissfully low interest rates, or at least low in a modern context. Low interest rates give companies cheaper access to investment cash, allowing them to become more profitable. Low interest rates also induce investors to load up on stocks, since the low returns on bonds or even bank deposits aren’t as attractive.

And–more interest rate stuff–lower rates actually increase the value of a company’s stream of earnings, which, in turn, increases the value of its stock. This is rooted in “Discounted Cash Flow analysis,” which is how financial pros put a value on future financial activity. Lower interest rates increase today’s value of future profits.

One happy mystery is how a sustained economic boom (our first factor) can co-exist with low interest rates (the second factor). The usual assumption would be that strong economic growth would result in more companies expanding, which would increase their demand for money (so they can invest and grow). The increased demand for money would create higher interest rates. However, this factor seems to have been counter balanced by a benign inflation environment, which has enabled the Federal Reserve Bank to keep interest rates low, and the economic party rolling along.

In sum: the United States is having its cake and eating it, too. You’d be surprised at how well economies can do when people are willing to work and the government doesn’t meddle in every aspect of the economy.

But, here we introduce factor three: tax shelters. The yuppies, the soccer moms, the shopping mal sheep, the union men, they’re all forking money into tax deferred retirement accounts. A lot of this money finds its way into the stock market. In this sense the United States has meddled in the market big time, because it is using tax laws to create an artificial incentive to invest (speculate?) in stocks. It makes the Wall Street vampires happy, and they’ve got a few of their own in the White House.

And that pretty much sets the stage. Will the Dow hit ten thousand? I guess so. But here’s my take on the script: If there’s a vampire in the room in the first act, he’ll bite somebody by the time the curtain is drawn.