What the Dow Jones Industrial Average Reaching a New High Really Means

What the Dow Jones Industrial Average Reaching a New High Really Means image Dow Jones Industrial Average Reaching a New HighDow Jones Industrial Average Reaching a New HighI’ll be the first to admit it. I never thought it would happen, the Dow Jones Industrial Average moving to a new record high. But who was I kidding? When trillions of dollars in paper money are created out of thin air and interest rates are simultaneously reduced to zero, where else would investors put their money?

But in the end, we’ll find out that the bigger the rise—a rise in stock prices based not on fundamental improvements to the economy, but on artificial changes to the money supply—the bigger the fall.

Here’s a chart of the Dow Jones Industrial Average:

What the Dow Jones Industrial Average Reaching a New High Really Means image INDU Dow Jones Industrial Average stock market chart$INDU Dow Jones Industrial Average stock market chart

Chart courtesy of www.StockCharts.com

From the chart, we see a long upward trend in the Dow Jones Industrial Average culminating in new highs reached yesterday. To me, the chart above depicts the end result of increased paper money printing and artificially low interest rates. Sadly, as the headlines have changed, investors have become more optimistic than ever—and this is very dangerous.

What if all we have seen since 2008 is a sucker’s rally in stock prices? After all, corporate earnings growth has turned negative. The U.S. economy is close to contraction. Unemployment in the U.S. remains pathetic. The eurozone situation is deteriorating. Corporate insiders are selling stock at record levels. Bullishness amongst stock advisors sits at multi-year highs. U.S. corporations are buying stock and cutting payrolls to keep profits up because consumers have pulled back on spending.

Under the above scenario, how can the rise in the Dow Jones Industrial Average be real?

By implementing quantitative easing and low interest rates, what the Federal Reserve has essentially done is drive investors to stocks. Just look at 30-year U.S. bonds. They provided investors with a five percent yield prior to the financial crisis; now the yield on the same U.S. bonds is 40% lower at around three percent.

Investors are taking on extra risk just to get back to the returns they once enjoyed. As a result, they are rushing toward the companies in key stock indices like the Dow Jones Industrial Average, not because they are cheap, or undervalued, but because there aren’t many other options for investors out there. Ten-year U.S. Treasuries are yielding negative real returns when you take inflation into account.

I believe the longer the Federal Reserve continues with its quantitative easing and easy monetary policy, the bigger the eventual problem is going to be. Consider this: what happens to the Dow Jones Industrial Average when the Fed stops printing paper money, stops purchasing U.S. bonds, and starts to raise interest rates? The opposite of a rising stock market is what happens.

The Federal Reserve has increased its balance sheet to over $3.0 trillion through quantitative easing and continues to do the same in multiples of $85.0 billion a month. An eventual Fed balance sheet of $4.0 trillion isn’t farfetched.

Dear reader, don’t get lured into the belief that the economy has recovered and the stock market is a safe place to invest again. I’m preaching caution.

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