Stock Market Performance

7This negative correlation is made evident by looking at the performance of the Dow Jones IndustrialAverage during the most inflationary period of the United States in this century, shown Figure 6 above.As can be seen, this benchmark index did not rise on net at all over this period, which lasts more than adecade. (Dividend yields, which were around 2% annually during this period, are not represented inFigure 6.). Considering, in fact, that there was severe inflation during this period, the purchasing powerof investments in stock actually fell more than 50%.In part, this inverse reaction can be attributed to a portfolio effect, also called a portfolio shift. Theyields on interest-bearing portfolios, many of which are not very risky, begin to look very attractivecompared to much riskier stocks. This is especially true of overseas investors who may be leery ofinvesting in U.S. stocks because of exchange rate risk and their memories of recent market malfunctionsin the United States.Figure 7 shows a simple hypothetical example of a portfolio effect. Professional mutual fund and hedgefund portfolio managers, responsible for balancing risk and yield in a large investment portfolioconsisting of many securities, including a mix of stocks and bonds 2 , will often favor stocks over bonds.This is also true of sophisticated retail (individual) investors who are pro-active in managing their owninvestment accounts. These same people, however, often rebalance (change the proportion of majorclasses of investment assets) the portfolios when economic conditions change.2 For convenience, the single term “bonds” will be used to refer to all interest-bearing assets, including bonds, notes, andbills.