Dancing with the Trend

Maintain a Proper Perspective

Watching the evening news can give you a misleading and often wrong perspective on the stock market.  Most commentators mention whether the Dow Jones Industrial Average was up or down and by how much, and that is just about the complete financial report, even though the Dow Jones’ 30 large blue-chip stocks do not give a good representation of the overall stock market.  It is a misguided focus.


The Dow Jones Industrial Average was created by Charles Dow in 1896, originally 12 stocks, but currently consists of 30 stocks.  Because the evening news has focused on the Industrial Average for so long, it is what most folks think of when they think of the market.  However, those 30 large blue-chip stocks do not give a good representation of the overall stock market.  The bear market of 2000-2002 saw the Industrial Average drop 37%, while most other markets indices dropped significantly more.  The S&P 500 dropped over 47%, the Russell 2000 Index dropped more than 46%, and the Nasdaq Composite Index dropped more than 77% (more than twice that of the Industrial Average).

I think I know why all this is so; Charles Dow was neither a broker nor financier, but a journalist.  Keep your focus on more than one market index and don’t let a “talking head” influence your investment decisions.  Personally, I focus on the Nasdaq Composite (large dynamic blend marketplace), S&P 500 (large cap blue chips), and the Russell 2000 (small cap issues).  My once favorite New York Composite Index now contains entirely too many stocks that are interest sensitive.  That means they could be influenced as much by the movement of interest rates as they are by normal market forces.

Recently the Dow was reported to be reaching a “new high.”  Remember the following key points about “new highs”:

  • New highs are almost always good news; it’s just the last one that is not.  In other words, you should worry when something is not reaching new highs.
  • To say that something is about to make the new 6-year high is essentially the same as saying it has not gone anywhere in 6 years.  It took the Dow 16 years to reach a new high between 1966 and 1982.

Contrary to conventional wisdom, you do not make money 75% of the time just because the market rises 75% of the time.  Why not?  Because the market must recover from the down years before you can start making money again.  During the last 50 years, the market reached new highs just 40% of the time.  In other words, buy and hold investors have spent 60% of the time losing money or trying to get back to even.

The forces driving the markets are far too complex and forward looking to credit or blame any single event for any given day's activity. Something to remember the next time you hear someone say the markets did this because of that.  I’m going to give the financial media a break and not discuss their inability to provide anything of value over the next few articles.

Dance with the Trend,

Greg Morris

 

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