DJIA or Fear Index?

Dow Jones Industrial average is jittery. So what does this mean? The media would tell you that the markets are jittery because S&P downgraded T bills and that a double-dip recession is around the corner. Stock prices are indicative of two things: underlying value of companies in the long run, and investor confidence in the company in the short run. Theoretically, the stock market is believed to be efficient and therefore movement in stock prices is assumed to indicate a company’s value or long term profit potential. In the short term market decline only indicates one thing: investor fears or uncertainty about stock prices in the immediate future.

Shareholders’ reaction in this case does not follow that the asset values of companies or their potential for making profits has dropped or disappeared overnight. When investors pull the money out of stock markets it goes into other investments (I don’t believe people stash money in mattresses anymore). Currently the money is flowing into T bills and corporate bonds in the expectations of higher interest yields. In the short term cost of debt goes up. In the long term companies react by adjusting their balance sheet leverage (degree of debt compared to equity) to maintain an affordable weighted average cost of capital. As long as markets exist for its products the company continues on albeit a slightly different weighted average cost of (debt and equity) capital.

For the long term viability of the economy through job growth we should look to indicators such as employment, innovation, technological inventions, education, and the overall health of the nation. And we need to elect representatives who can make sensible long term policies instead of playing senseless short term politics.

See America’s Workers Get Stiffed.

posted by Yaso Thiru