With the huge rise in the stock market in the past month, you're going to be hearing a lot more about all-time records for major market measures. The Dow Jones Industrials (^DJI 1.09%) is only about 200 points shy of its record closing high of 14,164.53, set on Oct. 9, 2007. Although the Nasdaq Composite remains well off its records from when the tech boom of the late 1990s came to its climax in March 2000, the S&P 500 is similarly close to its own high, less than 4% below its record of 1,565 from the same day.
For all the attention the approach toward the milestone will get -- regardless of whether it's reached -- you need to remember that it's completely unimportant. Let's look at three different but equally valid reasons why.
1. Inflation
The first reason comparing index levels across time is misleading is that indexes aren't adjusted for inflation. As this article from Fool contributor Alex Dumortier in 2006 shows, even if the levels of the index are the same on two different dates, those who invest in index products won't have the same purchasing power as they did before, because inflation will affect their real return.
In particular, since October 2007, the Consumer Price Index has risen by about 10%. By that argument, the Dow would need to climb above 15,500 in order to set a new record level adjusted for inflation. Similarly, the S&P would have to go well above 1,700 to set a real record.
2. Dividends
The second reason index milestones are irrelevant is that they don't include the positive effect of dividends. Unlike inflation, which tends to make the true record figure higher than the reported value of the index, dividends lead to new records on a total-return basis even when the nominal Dow is below past highs.
According to Barron's data, the Dow's latest dividends over the past year have added almost 350 points to the average. The corresponding figure a year ago was 320 points. Although dividends have fluctuated greatly over the past five years as the financial crisis led many companies to cut their payouts dramatically, the net impact of dividends means that on a total-return basis, many Dow investors have already seen their asset levels reach record highs.
3. Individual stocks
Perhaps the most important reason Dow records aren't important is that they don't really reflect on individual stocks. With 30 different components, the Dow reaching a record high doesn't have any marked impact on how badly laggards are lagging or how well outperformers are doing.
For instance, take a look at the performance of the Dow's members since October 2007. You'll find wide variations in performance:
- Home Depot (HD 3.20%) has been the best performer over that time, rising by 134%. As an early victim of the slowdown in housing, Home Depot has rebounded strongly, hitting successive decade-long highs throughout 2012 before hitting all-time highs recently. With housing still recovering, Home Depot could have even further to climb.
- McDonald's (MCD 0.75%) avoided the market meltdown in 2008, actually rising in value in that year. That helped the stock almost double since late 2007, although more recent concerns about growth have held the shares back over the past few months.
- At the other end of the spectrum, Bank of America (BAC 1.97%) and Alcoa (AA +0.00%) remain more than 75% below their levels from late 2007. For B of A, the financial crisis has made a lasting mark on the company, and even as the bank's operations have stabilized and improved, many are doubtful that the banking industry will ever be the same again. Alcoa, meanwhile, has dealt with a tough aluminum market, and the Chinese economic slowdown has taken its toll. It will need a return to strong economic growth in order to have any chance of recovering its lost ground.
For high-flying stocks like Home Depot, a Dow record is meaningless because it has already been doing well. For Alcoa and B of A, it's meaningless because their shares aren't even close to getting back to pre-crisis levels, let alone new records.
Go your own way
If you need an excuse to celebrate, then paying attention to talk of Dow records is a harmless diversion. Just recognize that it's meaningless before you get swept away in all the hoopla.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.
