U.S. Stock Market vs. the Economy

by Arthur MacEwan

Dollars and Sense magazine, September / October 1997

Every day, the network news reports changes in the stock market using the Dow Jones average. The Dow is calculated by the Dow Jones Corporation, the publisher of The Wall Street Journal, and measures changes each day in the stock prices of 30 large corporations.

Changes in the stock market can have a quick impact on the finances of the 10% of Americans who invest heavily, owning 85% of all stocks. Yet for the 71% of the population who own no stock or less than $2000 worth (even in pensions or mutual funds), the Dow has no im mediate relevance. So what does a high Dow mean?

Stocks are shares of ownership in corporations. So the amount that investors are willing to pay for stocks tells us what they think about the well-being of corporate America. If these investors- rich individuals, and managers of pension and other investment funds-believe profits will be growing strongly in the coming period, they will be willing to pay more for their shares of owner ship. Then the Dow will rise.

Over the very long run, the stock market has gone up as corporate profits have increased. Yet the market's swings are much more extreme than the ups and downs of production and corporate incomes. A good deal of the swing reflects the stock market's speculative nature; it is a huge gambling game at times driven more by the psychology of investors than by economic analysis. For instance, some analysts think investors are paying too much for stocks even though corporate profits are fairly strong-hence Federal Reserve Chairman Alan Greenspan's warning that the market suffers from an "irrational exuberance." Also, some observers think that the more that wealth is redistributed to the top earners, the more they will speculate in the market with their ready cash.

Occasionally the stock market actually channels money directly from buyers to corporations. This occurs in less than 1% of trades-when investors buy stocks just issued by companies. The other trades are resales of existing stocks from one investor to another that do nothing to put more money at the disposal of corporations.

In the middle of the summer of 1997, news from the stock market seems to show that in the eyes of investors the prospects for corporate profits are very good. Indeed, for the last 15 years, the stock market has expanded at a remarkable rate. In the early 1980s, the Dow was less than 1,000. Ten years later, it had topped 3,000, in spite of a crash on October 19, 1987 when the stock market plummeted 508 points and lost about 23% of its value. By the end of 1996, the Dow Jones had risen above 6,000 and as of this writing it had reached the peak of over 8,000.

Once adjusted for inflation, the rise in the stock market between 1982 and the end of 1996 is still substantial at 343%. In contrast, the inflation-adjusted value of the Dow Jones dropped by roughly 70% between 1965 and 1982.

One lesson to learn from the recent period of a rising Dow Jones and rising profits: For many people, the strong growth of corporate profits is not necessarily a good thing. ... the well-being of corporate America is based in large part on a deteriorating situation for many working people. Lately, corporate profits have risen in part as a result of shifting in come away from working people to those who own and run corporations.

There have been times when expanding profits for U.S. corporations have gone along with expanding incomes for working people. Through the 1950s and much of the 1960s, profits, wages and the Dow Jones all grew together. Not everyone shared equally in that "era of prosperity," but gains were relatively widespread.

Unfortunately, although a high Dow does not necessarily signal a good economy for all, a bust is bad for almost everyone. If the Dow drops drastically and stays down, it is usually following some fundamental economic crisis that hurts working people.

If experience is any guide, the current boom of the stock market will be followed by another drop.

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