This question always comes up when the market hits a new low. Conversely, whenever the market surges someone askes "how high can it go?" so its not like the situation is unique to just right now, today.
If we simply define the Dow Jones Industrial Average as a measure of confidence in the U.S. economy, then you could say that the Dow could easily reach zero. However, the DJIA is an average, and there are publicly traded companies, like Walmart, that are doing quite well. So it's highly unlikely the DJIA would drop to zero. But it is possible for other measures, like the S&P 500, to drop to zero. These measures follow a certain set of companies and it does not change from day to day. A sudden collapse in a large percentage of these companies could drive the S&P 500 to near death, while the overall trading on the floor in New York could still be humming along briskly.
The other factor, to me, that prevents the DJIA from dropping to zero is that lower prices for stocks encourages buyers. There is a point where even a paranoid delusional anti-investor like myself goes "Holy cow, Garmin stock is below 5 dollars?!" and invests a couple grand in Garmin stock, knowing that the company will inevitably recover when the rest of the economy does.
What I find the most interesting, however, is that the stock market is down, way down, since President Obama's election in November. The DJIA is down 17%, which seems paltry in the face of the overall scheme of things right now, but if this were 2005 and the Dow dropped from 12,500 to 10,300 there would be panic in the streets.
Also, since the passage of the economic stimulus, the Dow has risen for only 1 day. Investor sentiment on the trading floor is very low because most believe that the current administration has no more clue how to bounce the economy back than the last one did.
Important note: the rise and fall (and fall and fall) of the stock market should not be used as a measure of the economy. Although the stock market is off more than 40% from its high earlier this decade, the economy is actually significantly larger than it was at that same point. And though the market is down 17% since President Obama was elected, the economy as a whole is down far, far less.
As far as how fast will the economy will recover, I'm not sure it ever will. My mind says it will, but my gut is telling me to start stockpiling food. I am just happy I took the minimum deduction into my 401k this year, I've only lost a few hundred dollars, many of my coworkers have had thousands wiped out. Of course, if they don't withdraw their money early, they can pray for a recovery. But dollar-cost averaging can only get you so far when the economy L's instead of U's.
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2 comments:
The problem with the stock market being used as an accurate judge of the current economy, (to piggy back on your comment of how it shouldn’t be used as an accurate judge of the current economy), is that it is procyclical. When it shoots up it chases itself up higher and higher and higher. The same is true in reverse when it drops.
What kind of freaks me out is reading that the current P-E ratio for the S&P has just now reached its historical average (roughly 12-13x). It's much lower still in the bear markets of the 20th century. That gives you a sense of just how inflated asset prices had gotten--up to 40x P-E at the peak. That's crazy.
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