"Kee" Points with Jim Kee, Ph.D.

Markets were up strongly yesterday (Monday), largely erasing last week’s losses. Optimism comes from last week’s jobs report, which came in at a solid 215,000 jobs created for the month of July, and the ISM’s Non-manufacturing (i.e. “services”) index, which showed accelerating growth in the services sector. The announcement that Berkshire Hathaway intends to make its largest acquisition ever (buying Precision Castparts for $37 billion) also seems to have given the market a brief psychological boost, as cash deployment is generally seen as an optimistic move. China’s market also rallied strongly, leading to some hope that the stock market decline there has bottomed. Interestingly, the August 6th release of the Fed’s GDPnow forecast for 3rd quarter estimated GDP at 1%. That’s a pretty low number, and it will be revised continuously throughout the quarter as new data comes in. Given its recent, above average track record, it serves as a pretty good reality check to excess optimism regarding US growth!


GDP reminds me of a fun piece of research that I’ve shared before from the Georgia Institute of Technology titled “Seeking Guidance for the Dow? Try GDP”. It was intended to provide long-term perspective on where stocks are heading. It seems a little silly, but I’ve found it useful, far more useful than forecasters by the way, and maybe you will enjoy it too. To make a long story short, the Dow Jones Industrial average tracks nominal GDP quite closely. The authors note that even though the constituents of the DOW 30 stocks have changed over the decades, their revenues as a share of GDP tend to be pretty stable, so GDP becomes kind of a crude multiple toward which the DOW always returns. I can think of all kinds of reasons why this shouldn’t make sense (e.g. globalization of sales/earnings), but it has nevertheless been an excellent long-term guide. Plus it is kind of fun. Here are a few key periods:


1929: A big deviation occurred in 1929, when the Dow averaged 311.2, exceeding GDP of $103 billion by nearly 200%. By 1932 the discrepancy was largely erased as the Dow, at 64.6, was much closer to GDP, which was by then $58.5 billion.


1970’s – 1990s: Another departure occurred during the 1970s, and by 1982 the Dow was 73% below GDP. The authors contend that the 1980s and 1990s were a case of “catch-up.” By 1994 the Dow was 46% below GDP, and by 1998 the difference between the two was eliminated. The Dow exceeded GDP in 1999 and 2000 (the tech boom), but by 2001 the two were again identical as the market corrected.


2007-present: The Dow reached above 14,000 in 2007, which was in-line with then nominal GDP of $14,291.3 billion. Then of course the Great Recession hit and stocks crashed. As GDP started to recover in the summer of 2009, so did stocks, which had fallen far more in percentage terms than nominal GDP.


Today: The point of this exercise is not short-term trading or market timing, as the DOW can run above or below nominal GDP for years. And temporary pullbacks (declines of 5%), corrections (declines of 10%), and even bear markets (declines of 20% or more) are to be expected. But the relationship between the DOW and nominal GDP always seems to assert itself, which provides a rather unique long-term viewpoint of the market. So…the 2nd quarter GDP number came in at $17,840 billion. The Dow yesterday was just below that at 17,615 (down from a peak of 18,300). I find that uncanny!