Saturday, 21 March 2009

Twenty year perspective on the DJIA - living dangerously


If one retains the two underlying variables, from the previous two postings, for continuity in reference points - the ten year yield and the Nikkei 225 - but added on the chart below is the Dow Jones Industrials Average (DJIA). The base period chosen is mid 1994 which preceded the large run up in the Nasdaq and tech stocks of the 1990's and which takes us back far enough to gain a perspective on some key levels for the DJIA.

As can be seen from the chart the DJIA has recently come down to levels not seen since 1997 and as the recent dip below the horizontal line suggests this index is currently living dangerously. If the index was to break down below the 1996/7 levels there is more than a theoretical possibility that US equities in general could have substantially further to drop. Not to the same extent as the Banking Index which has converged with the deflation variables but certainly another 20% below the early March levels is a distinct possibility.

What can alleviate this troublesome scenario - in a word inflation and a kick start to the single most worrisome asset class in the whole equation - US residential and commercial real estate prices.

For some thoughts on this matter I shall quote from another article that I wrote yesterday on the reasoning behind the QE move from the Fed this week.

The best way to consider the timing of the QE policy is that it is tied pragmatically to the US real estate market and that the Fed is being encouraged by, and hoping to germinate, anecdotal evidence that the bottom may be in sight and that this is a good time to be providing maximum support to the mortgage origination and re-financing market.

Not just in the US but in many parts of the world, central bankers are now becoming desperate to try to ignite some spark under their property markets. Much more so than even supporting equity markets, central banks know that the most damaging form of wealth destruction (and the evaporation of consumer confidence) is evidenced by the perception that property values remain in free fall.
Will the QE inspired reduction in mortgage rates spark some life into the US property market?
It is highly unlikely on its own to do so because the Fed and other central banks appear to be overlooking the fact that only macro increases in income levels will be able to drive a sustainable recovery path. Residential and commercial property prices/rents are still not genuinely affordable, and will not become so while final demand and levels of employment are declining and, notwithstanding even both of those changing direction, it can be further argued not until the median value of a family home has reverted to a more historically sustainable alignment with median family income.

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