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INVESTMENTmatters |
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The Dow Delusion
September/October 2006 - Issue 48
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The Dow Jones Industrial Average, perhaps the most watched stock index in
the World, has made a new all time high, albeit that it’s taken nearly 7
years to do so.
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But if we look beyond the headlines, there is a
different story. The index is composed of 30 stocks and of these, fully
one third of them - 10 stocks - posted their all time highs last
century, in 1999. A further ten stocks made their all-time highs in
2000. Only 7 stocks made their new high in 2006
The index is at a new all time high, but 70% of its components are
down by 20% or more! Some record high!
If one factors in inflation since the 11750 high of 1999, as measured by
the, Fed, the index would need to reach 13817 today to be at a genuine
new high.
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If priced in ounces of Gold, or real money, any
notion that the Dow is at an all time high looks absurd.
For a more realistic view of the US Stock Market one should observe the
S&P 500 index, a far more representative guide of America’s finest.
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This index remains 12% below its all time high and that’s also in
nominal terms, not inflation adjusted. The big three European indices,
the FTSE 100, CAC 40 and the DAX are very similar to the S&P 500.
Looking at the NASDAQ 100 index, the darling of the late 1990s mania, it
hasn’t even managed to recoup a quarter of its substantial losses of
earlier this decade.
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It still remains over 60% off its all time high of 7 years
ago, despite bullish sentiment extremes rarely seen in history.
On investor sentiment we would like to make a few observations:-
According to “Investors Intelligence”, who monitors the opinions of US
published advisors, only 9 of the past 416 weeks have seen more Bears
than Bulls. So the past 8 years we’ve been in a period of sustained
optimism for the longest period in history, despite the fact that this
period includes the largest decline in the S&P since 1929-1932.
Their Short Term Composite Indicator, a proprietary summary of 29
different market measures which oscillates between values of 0 and 100
has recently topped 90, the largest overbought extreme in almost 6 full
years, at the end of the late 1990s mania.
Daily Sentiment Indices are showing very rare readings of 90%+ stock
bulls, which mean that less than 10% of stock traders’ think that stocks
are going down.
We look at many historic indicators, including sentiment and momentum.
When momentum diverges against price, it adds another warning sign.
Our final chart shows the long term Dow, with a momentum indicator shown
in the lower window in black. |
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You will note three occasions when divergence occurred,
marked by the arrows. The prior two periods preceded the 1987 crash,
where stocks fell by 35% and the 2000 top (for all but the Dow), when
50% was wiped off blue chip indices and far more from the technology
indices.
The divergence within the US blue chip indices, including the venerable
Dow, has lasted longer than the other periods and, as with the sentiment
readings, look to be extreme.With the American
economy slowing fast and a yield curve which has remained inverted for
months, a recession appears to be on the horizon. Add to the mix
plunging national housing sales and prices showing their first declines
since 1993, not forgetting a seven straight month of decline for the
index of leading economic indicators and the highest inflation reading
in 11 years, a stock market correction would seem assured. |
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Perhaps the only matters standing in the way are the 7th
November elections where the Bush administration is desperate to refocus
the electorate’s attention to the “perceived” state of the economy,
rather than on Iraq.
A stock market on steroids and falling Oil prices to boot may just do
the job, only time will tell.We honestly didn’t
expect to see the 1990s mania again, but in many ways this is worse.
Easy credit has been leveraged many fold by the Hedge Fund community in
an effort to negate diminishing returns.
As a final “throw of the dice” the SEC looks set to
approve the NYSE request to reduce stock margin requirements to 15% from
the current 50% (Up until the 1929, investors’ could put as little as
10% margin on loans to buy stocks, but following the crash and the
subsequent depression, the SEC was created to avoid a repeat
performance. Monetary policy was tightened and margin requirement was
lifted to 50%, where it has remained for 72 years, until now that is.) |
An asset value held up by nothing other than debt is an Illusion of
wealth. The Dow’s new nominal high is a delusion against the broader
market.
This looks to be a sucker’s rally. Try to avoid being the sucker. |
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Charlie Aitken |
September/October 2006 |
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