by Mark Scheinbaum
American Reporter Correspondent
Boca Raton, Fla.
May 10, 2006
HOW NOW, CROWNED DOW?
BOCA RATON, Fla., May 10, 2006 -- The news media will soon crown a "new all-time high" of the Dow Jones Industrial Average (DJIA). Try to stifle your yawn.
This much fuss means it's probably a good time to review my own "Investing 101" philosophy.
As a surrogate for the broader stock market, global markets and economies and even the U.S. economy, the DJIA is a poor leading indicator and literally a shadow of its former self.
The "Dow" is the invention of smart editors and smarter marketers for the Wall Street Journal's parent company, Dow Jones. When it was convenient to talk about the clone of Rust Belt America, the Dow 30 "Industrials" were the iron, steel, and locomotive force that moved a nation. In recent decades the DJ Index has been doctored to conform with popular culture and to cull multi-year losers.
Before the recent boom cycle of natural resources and commodities, the largest private landowner in the world, International Paper had fallen from analysts' grace, and languished in Dow doldrums. It was dropped from the index.
AT&T in various incarnations is either in the Dow or out of the Dow, depending on the year and on which Baby Bell merger is hottest. When Microsoft and Intel focused Wall Street "buzz" on the then-fledging NASDAQ instead of the blue blood New York Stock Exchange, these tech stocks suddenly were dubbed "industrial" stocks.
This was great during the go-go '80s and the tech years that ended in 2001, but has helped make the DJIA anachronistic, a relic of bygone days. Wal-Mart is lots of things, but since the old Sears, Roebuck & Co. was dubbed an "industrial," the giant retailer Wal-Mart certainly has to be an industrial club member, right?
The S&P 500 and 100 Indices, the Russell 2000, and other baskets of stock seem to be a better reflection of where investors have risked their money and where they are heading in the future than the DJIA.
If you judge the "market" by the "Dow," you were basically dead in the water for the last six years. The achievement of Dow 12,000 actually would actual place the "buy and hold" investor back to chart patterns called "resistance levels," etched in 1999 - nearly seven years ago.
I was not alone in writing earlier this year, and before that, that a Dow 15,000, or 20,000 or 25,000 in the next decade is a necessity rather than a pipe dream. Going back from 1987, the year of the last major "crash" to the present day, we have seen months and years in which Dow investors pulled their hair out waiting for the Godot of Wall Street. Normal historic growth rates should rationally move the Dow and the broader indices ahead for the next few years.
The problem is international politics, spiked with interest rates. They are not rational.
Since Sept. 11, 2001, a number of money managers, myself included, have been more likely to "pull the trigger" (excuse the pun), and take small and modest gains "off the table." Positions which used to be held for months and years are now held for days and weeks.
Gains of four, five, or six percent, locked in for a client in April, May or June, allow cautious portfolio managers to "go flat" with cash for long periods, knowing they've already booked gains that beat Treasury rates and certificates of deposit. Another terrorist attack on U.S. soil, and mounting war deficits, could also make the pullback in equity markets to single-digit returns look excellent to retail and institutional clients.
Finally, the interest-rate puzzle could easily drop the magical, mystical Dow back to 10,000 in short order.
To the amateur observer, interest rates of seven, eight, or nine percent certainly would not be shocking with, say, 30-year-fixed rate mortgages.
To the professional investment manager or monitor, "nothing climbs straight to the Moon."
Looking at the past two years and 16 (or more) Federal Reserve rate increases, history pretty much suggests a 50 percent retrenchment in rates.
The mortgages are a handy layman's reference point:
When those mortgages are seven percent, buy a long-term government, or corporate investment-grade bond for $100,000 at a time and hold it. In a few months or a year, if rates drop down to six percent, your bond is worth $112-113,000.
I don't make the rules; I just relay market behavior. At this point, you can take your profit and pay the lowered capital gains tax and reinvest your money, or do nothing, or - if you're in a tax-advantaged account, such as an IRA - just smile and pour yourself an expensive drink.
By the same rule of thumb, a pullback to five percent rates would price your bond at $124-126,000.
Obviously, the converse is true. If rates continue to climb for a third year in a row, when you open your newspaper and see "No Points To Qualifying Buyers! 30-Year-Fixed Just 8 Per Cent!," your $100,000 is now worth only $87-88,000.
Got it? One full-point move (100 basis points) in interest rates moves investment-grade, long-term bonds 12 to 13 percent inversely (in the opposite direction).
My estimate is that late in the third or early in the fourth quarter of 2006, smart investors will join me in placing "over-weighted," high-quality government, agency, and corporate bonds in their portfolios. By the time "Money Magazine," CNBC's Jim Cramer and "USA Today" point out that total return in these bond markets could annualize at 10 percent or more for 2007, smart money will move from equity to fixed income.
When the "big money" moves to where we contrarians have been for months,
I'll probably move money back to Dow stocks.