Dow Jones Accurately Priced? Don't Count on That

by Odysseas Papadimitriou on June 10, 2009

dow-jonesAccording to CNNMoney, all of the news surrounding the stock market in the past few months, “has been good news, or at least neutral news,” but nothing bad.  The rationale for all of these happy feelings is that the market has the ability to prognosticate for the worst of times, and did so in March when we saw the Dow dip to around 6,500.  Additionally, it’s believed that 6,500 represented a worst-case scenario that never actually happened, and that therefore we’ve seen the lowest of the low. 

While this perspective fueled the three-month surge, it lacks fundamentals that can be found on page one of Investing for Dummies.  Before we fall for the hype, let’s face the facts.  We are in uncharted economic conditions, and face headwinds that we’ve never seen before and that cannot yet be fully understood. 

The Mortgage Bankers Association recently reported that the first quarter of 2009 showed the largest quarter-over-quarter increase in foreclosures since it began keeping records in 1972.   U.S companies cut 532,000 jobs last month.  Excluding Wal-Mart, according to a survey by Goldman Sachs and the International Council of Shopping Centers, May was the 10th straight month of same-store sales declines.  The housing market is still suffering numerous problems and the GM and Chrysler bankruptcies represent the largest and seventh largest industrial failures in U.S. history respectively. 

The most unsettling facts on the horizon are that banks are still holding a significant amount of toxic assets and that we are running record and unsustainable deficits that inevitably must be reigned in.  When this happens American households will be further stressed and contracted – to what extent?  No one knows.  What does an economy like this rate on the Dow Jones Richter scale?  If threat of capitalism’s total collapse is a 6,500, what number should we assign to the rising unemployment or the collapse of national giants like GM and Chrysler?  Is the Dow correct now as it sits just under 9,000, or will we soon see a double dip?

It’s problematic to assume that the Dow Jones has accurately priced future events, or that it’s now correcting itself from overly preparing for a disaster we never saw.  After all, if the Dow was as wise of a sage as some are saying it is, why did it recently need to correct itself so dramatically and why were its predicting capabilities so dead wrong just a year and a half ago?  The Dow was up around 14,000 in October of 2007 and fell to around 6,500 in March of this year.  Now we’re to believe it has insights into to the fundamental health of the market?   I think I’d rather use my Ouija Board.  Facts and data are the main indicators of any stock’s potential success – NOT the baseless fluff that’s being proliferated by the media about the market’s physic powers. 

The argument that the Dow Jones has the ability to accurately prognosticate on the future is tenuous at best – especially in respect to the crippling events that seem to be on the horizon.  Instead of debating on whether or not the performance of the overall market is an accurate economic indicator, investors should be focusing on the strength, or lack there of, of individual companies.
 
No investments should be made before the following questions are asked and answered: Is the average company’s dividend yield high?  It is price to earnings ratio low? Is the company likely to be more or less profitable in the coming years?  How is it managing the current recession?  Essentially the basis of a true bull market is smart investors assessing the real world viability of companies as indicators of success, not a blind confidence that the market has already done that work for us.

Discussion

Coolhandluke
There is a professional giving out his own portfolio for free at www.slickbudget.com under the stocks tab. He releases another stock he owns once a week. Check it out!
July 13 at 12:09 pm

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