Dow Jones No Longer A Good Thing - 4 / 17 / 2009

I have not written in 3 days for the following reason - nothing has happened in these markets that is surprising to traders, to you, or to me. Ask yourself why the market has traded sideways (compared to recent weeks) amid earnings season reports. Traders have learned to limit their own exposure in this market, not get caught by intraday market reversals, and now we have a market that reacts independently of Large Cap and Dow Component earnings surprises. It continues to amaze me that research groups find any value in paying Banking sector research analysts, and frankly that they continue to appear in the media restating what every other bank analyst has said and that is considered at all valuable.

What we do have is a problem. Dow Jones Components will trade in relative collusion so long as traders continue to enjoy the liquidity and expected volatility the index DIA offers. The only breakouts we are likely to see in any of the shares of these companies in the index will be to the down side as short sellers pile in against earnings misses. But unless there is a bankruptcy fear, funds will use these short term down swings to cost average their existing positions and modest price swings will occur. Here's the problem: membership in the Dow Jones index will reduce a company's upside share price potential. It would seem that Dow Jones Index inclusion, in anything other than a bull market, is detrimental to shareholders. Look what happened to the mighty Intel and Microsoft (MSFT) when they became Dow Components. Their earnings increased dramatically, but their multiple to earnings decreased dramatically reflective of the super stable growth of its Dow Component co-members. MSFT was so beaten down, even though their growth opportunity remained dramatic, that they announced a dividend. Forced by the Dow Jones investors to behave like Du Pont.

Meanwhile I have already heard the talking heads justifying the lack of market upswing in individual stocks that have dramatically beaten earnings expectations, by stating "there was no surprise in results". Have traders and fund managers already decided to ignore research analysts in favor of their own analysis? No. Unfortunately we have proven our Dow Theory for this period of market history. Dow Index day traders are in control of the value of our economy. And their sentiment is "How do I make money today with the least amount of risk". I don't see this changing for many months to come. Stick with components that have been unfairly beaten down on a P/E relative basis, expect 30% appreciation in those components over the next 12 months, and be happy with those returns. Momentum, bad, Value, good.

Build Value Every Day

Brad van Siclen