Steve Blitz Morning Notes

The combination of easy monetary and fiscal policies has never been kind to equity market performance, at least in the post-war. By performance, I am looking at the ratio of the Dow Industrial Average to GDP. Since 1947 the mean and the median have averaged 0.76 but averages, as Mark Twain noted, are as useful as having your head in the oven and feet in the ice box and saying the average temperature is 72 degrees. This ratio fluctuates and has trended up or down for extended periods of time (see chart below).

Equity market performance is being measured as the DJIA divided by GDP because this ratio is the reason why money with an investment horizon approaching infinity invests in equities versus bonds. Bonds will return the coupon but the stock market will return the economy's growth. Investment horizons less than infinity make this investment tactic a bit problematic, as we have seen in the past few years. Consequently, if one believes we are entering or are already in a period when the equity market underperforms the economy then a large equity allocation doesn't make much sense.

As for what causes longer-term trends in the ratio, the Misery Index (unemployment rate plus the year-over-year percent change in core CPI) seems to be a fairly good indicator -- a negative correlation of -0.79. As for what drives the Index, it seems to be periods of tight versus easy macroeconomic policy. The era of tight macro policy that began on a Saturday night in October 1979 ended during the fourth quarter of 2001 when the dot.com bust recession collided with the beginning of the war on terror. If you believe we will be in the current easy policy mix for the foreseeable future, and it has hard to see how we won't be, the equity market will have its ups and downs and perhaps even more ups than downs but relative to economic growth the overall market will underperform.