Streetwise for Friday, August 10, 2018
“Two things are infinite: the universe and human stupidity; and I am not sure about the universe.” Albert Einstein
A contagion of hysteria periodically envelopes the financial markets; so, now is a good time to stop and get a grip on reality. Yes, the criers of doom have a field day with each market hiccup, even if it is just for a day or two. It appears that Chicken Little was an amateur and Einstein had it right, human stupidity is boundless.
Therefore, I continue to find myself taking a contrarian position to the veritable din of doomsday commentary emanating from the proponents of impending disaster, as they alarm the populace needlessly; a replication of Chicken Little’s playbook.
Now I know what you are thinking, do I really have the temerity and audacity to suggest investing in equities with the Dow Jones Industrial Average well over 25,000, given the current political situation both here and abroad?
As Little Beaver would say to Red Ryder, “You betchum Red Ryder.” In fact, I believe in equities as much today as I ever did. The blue-chip shares on Wall Street are now and will always remain excellent investments over a two to three-year time frame. Period. Clear enough!
Although the continual talk of a major pullback damages consumer confidence, the day-to-day fluctuations of the equity markets do not necessarily reflect what is happening in the real economy here or abroad. And investors are never mortally wounded by short-term share price fluctuations.
Moreover, whenever there is volatility, what always seems to come to the forefront is the Dow Jones Industrial Average. This index is simply not a good market barometer. It is old and creaky.
Furthermore, the industrial portion of the name is largely historical, as many of the current 30 components have little or nothing to do with traditional heavy industry.
And the index’s performance continues to be influenced by not only corporate and economic reports, but also by domestic and foreign political events such as war and terrorism, as well as by natural disasters that could potentially lead to economic harm.
Created more than a century ago by Charles Dow, co-founder of Dow Jones and the first editor of The Wall Street Journal, the Dow continues to be synonymous with Wall Street. If someone says, “how did the market do,” they are usually referring to the Dow. Professor Jeremy Siegel has said in the past, “It’s a crazy way to measure the market.”
The Dow is comprised of 30 stocks and the measuring system is so simple it almost seems arbitrary. Stocks are weighted only by price. That means that the highest-priced shares, such as Boeing, have the greatest impact.
For example, with a current share price of $351, Boeing has the highest stature in the Dow, despite a market cap of only $201.94 billion.
Apple, with its $1 trillion market cap and a $207 share price, represents only 5.71 percent of the Dow, versus Boeing’s 9.47 percent. Walmart with its $265.34 billion market cap and an $89 share price, represents only 2.45 percent of the Dow.
So, how is the Dow actually calculated? If the price of the 30 stocks in the index totaled $3,000, the average would be 3,000 divided by 30 resulting in an index of 100. However, if one stock worth $100 splits 2 for 1, with a subsequent price of $50, the average declines by 50 cents. Thus, the new Dow divisor, to maintain equivalency, must be changed from 30 to 29.5.
As of September 1, 2017, the Dow Divisor was 0.14523396877348. Using this Divisor, every $1 change in price of a stock within the average equates to a 6.885 (or 1 ÷ 0.14523396877348) point movement of the Dow.
So what investment measure should you utilize? Begin with economic growth. Although the rate of economic growth can and will fluctuate, an economy of our size means that there will always be a cornucopia of excellent investment opportunities.
The only proviso is you must convince yourself to hold those investments for at least two years. In doing so, you will likely chalk up annual returns that exceed both the market indexes and your expectations.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.