Why you need to ignore “the Market”…

stock quoteDear Mr. Market:

Here we go…Right off the bat we’re insulting you by suggesting that we ignore you! Well…it’s not really you, per se, that we’re telling folks to ignore but rather a stubborn “name calling” habit that 99% of people have.

 

Ask any financial advisor this question:  “How did the market do today?”

How he or she replies will tell you how they are trained to think. The same applies to any friend, neighbor, or colleague of yours. Anyone… Go ahead and try it. Whenever you ask someone how the market did or what they think of “the market”…they will inevitably tell you about the Dow Jones. The same goes for the media and just about anyone who reports financial news.

Guess what? They’re all wrong!

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 U.S. companies traded on the New York Stock Exchange. It was invented by Charles Dow in 1896. For the record, that was obviously long before CNBC or entertainers like Jim Cramer were throwing things at the wall or slamming sound effect buttons in the studio as they deliver financial “news”.

Just because something has been around for over 100 years doesn’t necessarily mean it’s stale but in this case nothing could be more antiquated in describing the stock market by using the Dow Jones. Here are a few reasons why that is:

(1) The “Dow”, as it’s affectionately called, is only made of up 30 U.S. stocks. What country made the computer, phone, or tablet that you’re reading this on? What country manufactured the alarm clock that woke you up this morning? Where was the car built that helped you get to work or your errands today? The point is that we obviously live in a world that has tons of opportunities outside of the United States. Even if several of the companies in the Dow Jones are “multinational” and generate revenue overseas, the fact remains that about 60% of the world’s investing opportunities are abroad! If you only invest in the U.S., not only are you not properly diversified but you’re actually reducing your potential returns and believe it or not increasing your overall risk. If you check on one index daily find one like the MSCI World Index that measures performance of 24 developed nations (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States) More on that in a future article but for now do yourself a favor and don’t solely tune into a narrowly constructed index that makes up only 40% of the world’s financial markets.

(2) Again…it’s only 30 stocks. Sure, they are large and prominent companies but shouldn’t an index be comprised of at least a few hundred names if every news anchor is referring to it as “the Market”? At the very least take more stock (pun intended) in the S&P 500. One last pet peeve on advisors or newscasters reporting the markets is when you hear them report the daily numbers it’s typically how the Dow did and how the Nasdaq did. Really? To help add some “meat” to their reporting they tell you about the Nasdaq? Although this index has more stocks in it, at one point in time it was comprised of about 90% technology and biotech stocks ; that’s not diversification or worthy of being called “the Market” either.

(3) The Dow Jones is a price-weighted index. What this basically means is that each stock in the Dow influences the index in proportion to its price per share. Higher priced stocks are given more weight so they of course have a greater influence on the performance of the index. One stock with a high share price like IBM easily moves the market more than one like Bank of America (BAC). IBM trades around $207 per share and over the past year is up about 5%. Bank of America on the other hand trades at around $13 but is up over 92% in one year. If the opposite performance occurred would it be accurate to say that the “market” more than doubled? How about if a former market darling like Apple (AAPL) was in the Dow Jones? At one point over the past year it traded as high as $705 per share and dipped as low as $385 per share. If Apple were in the Dow it would’ve comprised almost 30% of the index’s weighting.  Giddy newscasters and financial talking heads would not be telling you that “the Market” broke 15,000 but rather we were somewhere in the neighborhood of 8,000.

And you thought 2008 was a bad year for “the Market”?!?

In summation, most people are simply unaware of “what’s under the hood” of this poorly constructed index. Hopefully you learned something about one of the most  miscommunicated market gauges there is. The next time you hear someone talking about “the Market”, forward this article and let them know about our volatile little friend…Mr. Market!

As always please leave your comments or feel free to contact us directly with any questions.

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