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The Dow is back to pre-Lehman levels. Does that mean everything’s ok? — Pop Economics

The Dow is back to pre-Lehman levels. Does that mean everything’s ok?

by Pop on November 5, 2010

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Let’s make a quick comparison.

This is a short post, and I’m sorry about that. For reasons apart from my work here, this has been a week from hell.

Remember how the world felt before Lehman Bros. collapsed? Bear Stearns had gone down, but some economists still thought it might just be a short downturn. An article about a month before the collapse concluded: “Is the worst over? Maybe, now that the largest possible victims seem to have been saved.”

The victims it’s referring to are Fannie Mae and Freddie Mac. They and most people didn’t understand how deep the ramifications that even a relatively small failure—Lehman’s market cap before failing was roughly a third of Fannie and Freddie combined before their takeover—could have.

Lehman turned all those forecasts on their head. It turned people from pessimistic to scared. For me, as I’ve written, the effect hasn’t really worn off. But what does the market say?

Pre-Lehman Brothers collapse

Unemployment rate: 6.2% (September 2008)

Per capita GDP: $47,464 (third quarter 2008)

Dow Jones industrial average: 11421 (closing price on Sept. 12, 2008)

Now

Unemployment rate: 9.6% (October)

Per capita GDP: $47,449 (third quarter 2010)

Dow Jones industrial average: 11,444

Sources: BEA, BLS, Morningstar

See any problems here? Granted, a lot more goes into stock prices than the two metrics mentioned. And heck, per capita GDP isn’t even that far off of where it was in 2008. But with unemployment sitting several points above where it was before the Lehman collapse, and people decidedly less optimistic about the economy’s next few years, it seems pretty surprising that the Dow managed to pass its pre-financial crisis level earlier this week.

So do investors have it right? I generally don’t advocate changing a stock allocation based on current events—you’re way too susceptible to emotions that cloud rational thinking. But sometimes it’s fun to take a stab at optimism when it seems to be getting out of hand.

First, some bad news: Average Joe investors are warming up to stocks again. Over 23 weeks, investors had pulled $92 billion (net) from stock funds. But just a couple weeks ago, stock funds broke that losing streak. It seems investors are finally losing their fear of stocks, which as a contrarian indicator, isn’t good.

Putting individual investors aside, it’s amazing that the stock market indicates that we’re back to the stage we were pre-crisis. Even though the economy has returned to expansion—on a non-per-capita basis, GDP is actually above where it was two years ago—it surely seems like the psychology of all those people we expect to buy things and invest in the country is damaged.

Sure, profits are at record highs again, but a lot of people think that’s because businesses are holding off on hiring and making new investments, which makes profit margins great in the short run but stunts growth in the long run.

But hey, what do I know that the market doesn’t?

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{ 3 comments… read them below or add one }

Zach November 5, 2010 at 11:09 pm

All those commercial investors soon to be falling over themselves to get in near the top.

Rob Bennett November 6, 2010 at 4:58 pm

what do I know that the market doesn’t?

The market is just millions of people like you, Pop. The market isn’t smarter than you or less smart than you. Not is the market more or less emotional than you. The market is you times millions.

I believe that we all know on some level of consciousness that the insane overvaluation of the 1990s that we treated as real at the time needs to be paid back. So none of us can ever again feel safe investing in stocks until the debt is paid. We ignore that voice of conscience at times and let prices drift back up for a bit. But the voice is too strong and insistent for us to ignore it for good.

The debt will be paid back . Just as we always knew it would. All $12 trillion of it. Then the rebuilding process will begin.

Rob

Brian November 15, 2010 at 8:36 pm

The market was probably overpriced in the months prior to Lehman’s collapse, and it is probably overpriced now. But I’m not sure there are any lessons to be drawn by comparing these two snapshots in time. The world today is very different today than it was back then. Sure, unemployment is higher now but the worst of the recession and the financial crisis is likely behind us, rather than in front of us. That the worst might be over could explain why investors are relatively bullish on stocks right now. Also, low interest rates has probably pushed up the stock market as investors chase gains they can’t get in the bond markets.

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