The Dow Is Not Normal: Here Is Why
February 18, 2009 by Vagabond Investors · 1 Comment
For those of you that like the stock market (as I do) I will ll give you a nut to crack. Many of you already know this, but those of you that are just starting out your investing career will find this interesting.
Many of you consider investing in Dow Jones. The market says that the Dow did this and The Dow did that. It is as if The Dow was a synonym for the overall stock market. If you think that that is a fairly accurate statement, hang on.
Why is it that The Dow is outperforming on the downside?
What is driving the index?
I will quote Mr. Bianco, CEO of Bianco Research LLC. In his excellent blog post entitled The Dow Is Distorted he made the following points.
The Dow Jones Industrial Average (DJIA) is a price weighted index. The divisor for the DJIA is 7.964782. That means that every $1 a DJIA stock loses, the index loses 7.96 points, regardless of the company’s market capitalization.
Dow Jones, the keeper of the DJIA, has an unwritten rule that any DJIA stock that gets below $10 gets tossed out. As of last night’s close (January 20), The DJIA had the following stocks less than $10.
Citi (C) = $2.80
GM (GM) = $3.50
B of A (BAC) = $5.10
Alcoa (AA) = $8.35If all four of these stocks went to zero on today’s open, the DJIA would lose only 157.3 points. The financials in the DJIA are
Citi (C) = $2.80
B of A (BAC) = $5.10
Amex (AXP) = 15.60
JP Morgan (JPM) = $18.09If every financial stock in the DJIA went to zero on today’s open, it would only lose 331.25 points, less than it lost yesterday (332.13 points).
If you want to add GE into the financial sector, a debatable proposition, then:
GE (GE) = $12.93
If the four financial stocks above and GE opened at zero today, the DJIA would only lose 434.24 points.
The reason the DJIA is outperforming on the downside is the index committee is not doing its job [emphasis added] and replacing sub-$10 stocks and the financials are so beaten up that they cannot push the index much lower.
So what is driving the index? [emphasis added] The highest priced stocks:
IBM (IBM) = $81.98
Exxon (XOM) = $76.29
Chevron (CHV) = $68.31
P&G (PG) = $57.34
McDonalds (MCD) = $57.07
J&J (JNJ) = $56.75
3M (MMM) = $53.92
Wal-Mart (WMT) = $50.56For instance if all the sub-$10 stocks listed above, all the financials listed above and GE opened at zero, the DJIA loses 528.63 points. To repeat if C, BAC, GM, AA, JPM, AXP and GE all open at zero, the DJIA loses 528.63 points.
If IBM opens at zero, it loses 652.95 points. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE and Alcoa combined.
The DJIA is not normal as the Index committee is not doing their job during this crisis, possibly because of the political fallout of kicking out a Citi or GM [emphasis added]. As a result, this index is now severely distorted as it has a tiny weighting in financials and autos.
Now that is something for you to think about. We have talked extensively about the impact of politics on the market as well as the bailout plan with its shortcomings. The stock market, if let alone, is one of the freest markets there are. However, everything is subject to manipulation by central bankers, politicians and the like who are easily mistaken as honest people.
I will thank Mr. Bianco for his excellent comment and give a direct URL to his article if any of you should be interested: http://www.ritholtz.com/blog/2009/01/bianco-the-dow-is-distorted/
See you guys!
Jaakko
Getting Rich With A Good Plan Is Almost Automatic
February 2, 2009 by Vagabond Investors · 4 Comments
Years ago I met an old friend of mine. We had studied entrepreneurship and finance together. He asked me to join him to eat lunch that week and I agreed.
Over lunch, he asked me what I was doing. I told him I was an entrepreneur, investor and a coach to many people who wanted to become financially independent. His eyes widened and he wanted to know more immediately. He asked a lot of questions about financial independence and investing.
I told him my formula and what I had found out it really took to become financially free. I thought my friend would be excited to hear that. Instead, he was disappointed.
“What?” he said. “If it were so simple, why don’t more people do it?”
“I don’t know” I replied. “I’ve thought about the same thing.”
“I don’t believe you. Such a simple formula will not take you there. It has to be more complex. There has to be more risk. It can’t be that easy!” he said raising his voice. I could hear the irritation in his voice.
“I never said it’s too easy. I just said it’s that simple.”
“You’re lying” he said. “I’m getting out of here.” So he did and I was left alone eating Thai food.
I think my friend failed to understand that we don’t need to be deco-millionaires to be financially independent. We don’t even want the million dollars. We want what we think only those millions can buy. The truth is, most of our deepest dreams don’t cost that much.
As to the formula I told him, investing is not what most people think it is. Most people want a hot tip or a quick fix. They think that investing is complex and risky. Most people actually prefer complex to simple. They seem to think that if a formula is not complex and difficult, it can’t be a good formula.
To me, investing is not a magic formula. Investing is a plan. Investing is a simple, often boring and almost mechanical system of getting rich. Personally, I hate risk. To me risk is a four-letter word. There’s always some risk but it doesn’t have to be risky. I believe that when it comes to investing, simple is better than complex. Just look at the financial mess on the market today which was caused by systems so complex that even the brightest minds on the planet didn’t understand them. Human judgment is far more limited than we think. We’ve met the enemy, and he is us.
I like to keep it simple. If the formula is complex, it’s not worth following. Keeping it simple is always better. I realize why it’s so hard for most people to follow a simple plan. The reason is that it is boring. People want excitement and amusement. I want it too, but I find my adrenaline thrills somewhere else. I prefer simple, uncomplicated plans of getting rich. Because the world is changing all the time, my plan is constantly under revision but it remains simple.
A formula that has been a winning formula for wealth for at least 200 years is this: build businesses and have your businesses buy your real estate and paper assets. That’s it.
For most people, the real goal is to find a sense of financial freedom. They want freedom from the day-to-day grind of working for money. All they have to do is find a formula that will make them rich and follow it. When they’re found it, all it takes is discipline. When it comes to money, discipline is often a rare commodity.
As with my friend, you have to ask yourself how badly do you want it? Are you willing to keep an open mind and accept that investing does not have to be risky and complex? Are you willing to increase your financial IQ so that you can become financially independent? Are you willing to be honest with where you’re starting from and give it some time? Are you willing to pay the price?
My friend obviously didn’t. He thought it’s easier to work for the rest of his life. To me, that was too high a price. I have always chosen to pay the price to financial independence. That price is not always measured in money, but in deep feelings and courage to move on.
That is why keeping it simple is such a powerful idea. You will find the strategies and tools that we use on this website. In my opinion, the very best of them are the simplest ones.
Jaakko
