How long will it take for the Dow to return to 14,000?
Mar 3rd 2009 8:00AM
Updated Dec 4th 2009 10:37AM
The Dow continued to fall the first day of March, as it did in February, as it did in January, as it has done for 18 months, basically, since peaking above 14,000 in the second half of 2007.
What's more, February's plummet, like January's swoon, was another double-digit loss -- a drop of 11.7 percent. So, the obvious question no-doubt on the minds of many investors is, How long will it take for the Dow to return to 14,000?
To answer that question we have to investigate why the Dow fell from 14,000 to 7,000 in the first place. (As a brief side-note: I would argue that 7,000 is not the bottom for this market, as the Dow will likely test 6,000 this year, if it breaks through technical support at 6,300.)
Back to the 50 percent Dow wipe-out: Most investors known that the primary reason the Dow fell is because the end of both the housing boom and rising home prices prompted a rash of subprime loan defaults, which led to massive losses in mortgage-backed securities (now call toxic assets) that first devastated bank business models, then triggered a U.S. and global financial crisis.
Those constrained credit markets have rippled through the economy, preventing business and consumers from obtaining needed -- and commerce-generating -- credit, further reducing and deepening the recession that began in December 2007. The above led to large reductions in revenue and earnings (and in 2009-2010 estimates), which has sent the Dow down in stages, to 7,000.
At present, the world awaits a U.S. Treasury plan to remove toxic assets from the banking system, even as financial institutions seek to de-leverage and prepare for potentially even softer demand conditions ahead.
U.S. economy: Not enough consumers
Still, while the above does explain much of the Dow's nearly two-year fall, it does not tell the whole story. That's because, in truth, even when the Dow was at 14,000 the U.S. economy had major structural problems that had built up over a decade. These problems all but guaranteed a recession and a Dow plunge.
Further, the biggest structural problem is a difficult subject for many Americans because it speaks to the heart of the U.S. economic system. It's a problem many ignored for a long time, but the Dow's steady decline is clearly saying it can't be ignored now. The problem? Not enough Americans are earning incomes adequate to support U.S. GDP growth.
That's a difficult topic to breach because many Americans, the economic conservatives among them, believe that if the market says wages and salaries should fall, then they should and have to fall. Well, if that's the case, the U.S. is looking at a structurally unsound economy and it's hard to envision a return to robust revenue and earnings growth -- the basis for a rising Dow -- in that environment.
How did the U.S. get into this problem, essentially having not enough consumers with incomes high enough to support economic growth? The answer is not simple. A big part of it is globalization -- the transfer of jobs to lower-labor-cost production centers outside the U.S. Part of it is automation -- using machines to do jobs that people formerly earned incomes from. But there's another factor, one that New York Times (NYT) columnist and Nobel Prize-winning economist Paul Krugman has returned to again and again: the decline in unionization.
And that's what makes the topic so controversial. Union membership has been declining for more than 20 years and it has really declined during the globalization era's first decade. Most investors, and many Americans, believe the lower the costs for labor, the better for business. To a degree, they're correct -- just as long as you don't count on those same lower-wage citizens and neighbors for sales, and revenue and earnings. The U.S. does, and the result is declining revenue and earnings for Fortune 500 companies, and for most other businesses, and a Dow at 7,000.
The rise of the man from Illinois
Further, it's these relatively new (in U.S. history terms) lower-wage groups that form part of President Obama's coalition, which as you know, wants big change. So in that sense Obama's election is part of the solution to this structural problem involving too many citizens with too low incomes. Obama represents a major step toward correcting the problem. To be sure, these groups will not be the only voices as President Obama formulates policies to increase wages and incomes, but they do represent a critical voice, as they are part of his political base.
Some may assert that there's nothing Obama or Congress or anyone else can do to stop wages from falling in certain job types, or even increase wages of Americans, more broadly. Not correct, on both points.
Obama's new budget starts the correction process. He believes, quite soundly, that new engines of growth (including renewable energy, high tech, and a revitalized auto manufacturing sector); a large increase in higher education and vocational job training funding; increased support for unions; provisions to expand the earned income tax credit and to decrease taxes paid by low/modest-income workers and families will create good-paying jobs, provide more valuable skills for new workplace entrants, and increase the disposable income of tens of millions of Americans.
The above, along with other policies, will do much to correct the U.S. economy's structural problem of low wages and lay a foundation for sustainable growth. And with that sustainable growth -- driven by an economy with a better, more-balanced distribution of income -- revenue and earnings will rise, and so will the Dow.
But don't misunderstand: correcting this problem will take many years. For more than twenty years, most of the benefits of globalization have flowed to capital, and very little has flowed to labor. We'll need many years of a greater share of globalization's money amassed in labor's hands before one can say the U.S.'s structural problem has been solved.
And, of course, there will be those, the economic conservatives and most Republicans among them, who will categorically reject Obama's changes, or even deny that wages have fallen, or that the structural problem exists. Also, some might even argue that falling wages in certain job segments is a good thing, and that wages should fall more. Still others may argue that Obama's populist policies to increase the earning power and disposable incomes of low-wage groups represent socialism or "class warfare."
Investors can ignore the above charges, as they're moot, from a Dow-based, return-on-equity standpoint. For an investor, all that counts is the fact that the United States doesn't have enough citizens with incomes large enough to support GDP growth. Therefore, the nation must create some to get the economy moving again and on a sustainable growth track. When Obama's policies do this, that's when the Dow will rise again in a sustained way.
Financial Editor Joseph Lazzaro is writing a book on the U.S. Presidency and the U.S. economy.