Every time I write one of these blogs I try to talk in real terms. In other words – I always try to keep it real. But today I am going to talk in Real terms – that is, adjusted for inflation. Inflation, you may recall from my book, is not growth but a general rise in prices. When you hear “experts” speak in Real terms, they are referring to numbers adjusted for inflation. In this blog, my goal is to give you the Real story when it comes to today’s Market and its according activity.
The U.S. Department of Commerce released its first estimate of 1st Quarter 2012 Gross Domestic Product (GDP) and they’re not good. Let’s first remember that rarely do these first estimates ever hold true in the final analysis. So take these early releases for what they truly are: early indications. Especially early first quarter releases, which are annualized by multiplying by a factor of four, and needless to say, a difficult assumption in uncertain economic times like these.
However, these first estimates annualized growth to be a dismal 3.7% in Nominal terms (before inflation) and a pathetic 2.2% in Real terms. The difference between the two is the Bureau’s estimate for inflation: 1.7%. In other words, inflation is responsible for 46% of Nominal performance based on the most recent estimate.
One of the goals for the Dow Jones Industrial Average (DJIA) is to indicate total market activity using a strategically designed portfolio of publicly traded stocks. It consistently does so reliably (shown below), and since it’s not adjusted for inflation, it’s a Nominal indicator of market activity – not a Real one.
During this five-plus year timeframe the Dow gained 22%, and 71% of that 22% – or 15 of the 22% point gain – was produced by inflation (a rise in prices) not economic growth. That’s why the Dow should be considered over-valued here – its being driven predominantly by inflation instead of growth.
The Dow should only outperform Nominal GDP during times of economic expansion – a.k.a. Real growth. But the free-market is contributing less to economic output than ever before and GDP is inflated with reckless government spending and borrowing. That’s not growth. That’s inflating a recessionary market. It’s hype. It’s not Real.
These kinds of dynamics, inflationary stock market valuations during recessionary economic conditions, are a ripe condition for correction. Stock market inflation can be seen quite clearly from the 15-51 Indicator’s recent performance (see below).
During times of uncertainty, many baseline investment fundamentals migrate to the norm – a.k.a. the average, as indicted by the DJIA. That’s why the Dow and gold are hovering around the market average (GDP) trend-line, as shown in the above charts.
The 15-51 Indicator is better than average. That’s why it consistently outperforms to the upside and that’s also why you can see inflation easier and signs of correction sooner. In inflated markets, above-average portfolios will inflate more than average ones. During contraction, the 15-51 Indicator should produce a steeper correction followed by a steeper recovery. That’s just the way above-average portfolios perform in inflationary and recessionary conditions. Perhaps this can be seen more clearly in a longer term view.
Stock market inflation is blatantly seen in the 15-51 Indicator’s performance shown above. It’s already showing signs of correction – and it should! Like the whole Market, it’s really inflated and over-valued. If fact, should the aforementioned fundamentals hold true and 71% of the Indicator’s gain is simply inflationary, upon correction it should trade between 35,000 and 40,000 (it closed April 27, 2012 at 65,000), or 20,500 Dow points.
So far year this year the market (GDP) is up 2.2% in Real terms; after inflation “the market” is up three times that, gaining 6.6% this year; and the 15-51 Indicator is up an amazing 33.5% year-to-date – that’s 31.8% in Real terms.
Above-average construction makes it easier to buy low and sell high – becasue that’s how you make money – in Real terms.