WALL STREET: UPS AND DOWNS
NOVEMBER 22, 1995
The Dow hits 5,000 and makes history. Time to celebrate, according to Professor Sam Hayes of the Harvard Business School. He talks with economics correspondent, Paul Solman, of WGBH-Boston .
PAUL SOLMAN: What does it mean that the Dow Jones Industrial Average is above 5000 for the first time in its history? Joining us here in Boston to answer that question is Sam Hayes, professor of finance at the Harvard Business School. Professor Hayes, thanks for joining us.
SAMUEL HAYES: My pleasure.
PAUL SOLMAN: Let's begin at the beginning. The Dow hits 5,000, 5,000 what?
PROF. HAYES: 5,000 in terms of value of the stocks on the New York Stock Exchange. The Dow Jones Average is a collection of 30 representative stocks that are averaged in their value. You've got IBM, General Motors, Merck, and Kodak, and McDonald's, all these stocks together are then averaged out in price and they track the price every day to see whether the prices as a group are going up or down. And if you had been an investor and bought this 30-stock portfolio a year ago, you would have paid about $4,000 for it, and today it's worth $5,000, so you're ahead by 25 percent.
PAUL SOLMAN: Now, this is being ballyhooed, record, we've hit new records and so forth. Is this just a number, or have we actually hit an all-time record, and is it significant?
PROF. HAYES: Well, we really have hit an all-time record. This is the highest real value for the stocks on the New York Stock Exchange in the history of the Exchange.
PAUL SOLMAN: What about inflation?
PROF. HAYES: Well, even if you adjust for inflation, there has been a very substantial increase in the value of those shares over the last fifteen/twenty years.
PAUL SOLMAN: Can you give us a sense of how big an increase in value? The 1950s, what was the Dow Jones?
PROF. HAYES: In the 1950s, in the early 50s, it was about 100.
PAUL SOLMAN: A hundred?
PROF. HAYES: A hundred.
PAUL SOLMAN: And now 5,000.
PROF. HAYES: 5,000.
PAUL SOLMAN: So should we be tremendously happy as a country now that we've hit 5,000?
PROF. HAYES: Absolutely. Anybody that is a stockholder has got to be very happy to see their shares go up in value. They're richer, but at the same time, we have to recognize that these are not locked in, concrete return that you can expect to hold onto under all circumstances. In fact, we've seen times in the past when stock prices have fallen dramatically in a very short period of time. For instance, back in 1987, the stock market fell by about 25 percent in four hours, so nothing is, is to be taken for granted. But on the other hand, I think it's fair to say that over long periods of time the stock market has tracked pretty closely the growth in the U.S. economy, and so what the market seems to be saying today is that the outlook for corporate profits is very good, and it was likely to be good for a long time into the future.
PAUL SOLMAN: Now, the average American who doesn't own stocks, why should she or he care? Should they be happy as well?
PROF. HAYES: Almost everybody in this country is connected to the fortunes of the stock market in one way or another. For instance, many pension funds and pension accounts are, are paying out money to the pensioners as a function of how valuable the stocks are. So that's a direct correlation.
PAUL SOLMAN: Stop for a second. There are stocks in the pension funds?
PROF. HAYES: Stocks in the pension funds, and these stocks will go up in value and they will increase their dividends, and the, the pensions are indexed against what the height of the market is, and so if the market goes up, pensions go up.
PAUL SOLMAN: So you mean, so my pension fund, your pension fund has more money in it as the--
PROF. HAYES: As the stock market goes up, and as they then calculate what they can afford to pay out, they say, oh, the stock portfolio was worth 25 percent more than it was, we can adjust upward the amount that we paid Mr. Smith every month.
PAUL SOLMAN: All right. So that's good news for everybody who has stocks. But then, answer me this. We see at the same time that we hear about the stock market hitting record levels, the Dow Jones hitting record levels, we also see and hear reports of massive downsizing, of massive layoffs, of the very companies you were mentioning that are in this Dow Jones 30, this Industrial Average, so how does that square?
PROF. HAYES: Well, you know, we'd like to think that any increase in the stock market means that there's going to be more jobs. And in fact, I believe in the long-term, that's exactly what it does mean, that with a higher level of economic activity, we're going to create jobs. But we have to remember that stock prices are the present summation of all the future earnings that are expected from that stock, and many of the companies that are in that Dow Jones Average went through a very painful restructuring and downsizing during the 1980s to reduce their overhead and in the same time, they had to let a lot of people go. And so they've now got their overhead lower, which means that their profits are going to be higher as their sales rise in the future. There are fewer people being employed by those companies than there used to be, but as the economy grows, so should total jobs within the economy.
PAUL SOLMAN: But you mean that the people who are getting laid off are making these companies more profitable, and, therefore, people are buying the stock in them?
PROF. HAYES: They are, in a sense, casualties of this leaner and meaner corporate sector that is now so competitive in the world market.
PAUL SOLMAN: And that's why the stock market is going up, because it's so competitive?
PROF. HAYES: That's right.
PAUL SOLMAN: That's what you're saying. As a practical matter, do people do things differently if they have--if the Dow Jones Industrial Average hits new record highs, I mean, in terms of they have more money in their pensions and so forth?
PROF. HAYES: Sure. They spend more. They spend more. If you have a stock portfolio and it has gone up in value by 25 percent, you're going to feel a little bit looser with your pocket book. You're more likely to buy a new car or a new refrigerator, or to pay more for a house. Housing prices tend to rise with the stock market. So I think we can expect that if the stock market stays at this level and goes higher, that we'll see increased economic activity because of consumer spending going up.
PAUL SOLMAN: And we aren't scared that since it's hit historic highs, you know, they say, sell high, buy low, we're not afraid of a huge crash or something?
PROF. HAYES: We are always afraid of that, but at the moment, when we look at stock prices and look at the relationship of the stock prices to the earning power of the companies, they are in, right in the middle of the range at which they've traded in the past. So we don't have a situation where we're--we have very high valuations for stocks that with, with a pricking of the bubble, everything would collapse. So I think there's more sense of confidence that this will sustain itself.
PAUL SOLMAN: All right, well, Prof. Hayes, thank you very much for joining us.
PROF. HAYES: Real pleasure.