The Wall Street Waltz: 90 Visual Perspectives, Illustrated Lessons From Financial Cycles and Trends, Revised and Updated Edition

Chart 16

Stock Prices versus GNP

Have you ever heard of the old rule of thumb for measuring stocks as an inflation hedge? It is the ratio of the Dow Jones Industrials to GNP. Theoretically, as inflation pushes GNP higher, stocks should eventually follow. When stocks sell at historical lows relative to GNP, they're good buys. At historical highs they're bye-byes. Supposedly stock values should keep pace with GNP because business is a key and steady part of GNP.

It sounds good, but be skeptical. These charts show stock indexes versus GNP from 1955–1971 in England, France, Germany, Japan, The Netherlands, and the United States. Each index was adjusted to match it one-for-one to that country's 1955 GNP. Only France saw a major long-term variance between stock prices and GNP. Elsewhere folks did well during this period if they sold when the stock index was more than 130 percent of GNP and bought when the index fell below GNP.

How so? In 1965, the Dow Jones Industrials peaked just below 1,000. GNP was $725 billion. Divide 1,000 by 725—the result is 138 percent of GNP. By this theory, that would be a good time to sell. It was. Later, after 1972, stocks collapsed and ushered in a decade of the lowest levels relative to GNP since the 1930s. But GNP kept rising, fueled by an expanding economy and inflation. GNP is now $4 trillion—5½ times higher. According to this theory, to keep pace with the economy, the Dow Jones Industrials should not only have doubled in recent years, as it did, but ...