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Dow(n) Dooby Do, Dow(n) Dow(n)

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What are we supposed to do with all the “Dow 15,000” hats now? Keep them handy for another trip on the “Index Round Numbers Express” or just put them up on eBay in the “curios and collectibles” section?  ConvergEx's Nick Colas suggests one way to think about the question is to deconstruct the Dow into its 30 components and see which stocks got us to these still-respectable YTD levels in the first place.  For example, Colas notes that just seven stocks – MMM, BA, JNJ, AXP, DIS, HD, and HPQ – make up more than half the gains for the Dow in 2013.  Most of these names have a distinctly cyclical flavor, of course. And while the Dow has its share of “Defensive” names, it pays to remember that the top 10 companies by weighting take up 54% of the Average.  And they need a decent economy to grow earnings...

Via ConvergEx's Nick Colas,

What do the modern Olympic Games, Henry Ford, George Burns and the state of Utah all have in common?  The answer is a year: 1896.  Yes, 117 years ago Athens held the first modern games, Ford launched his first car, cigar-chomping comedian Burns came into the world, and Utah was accepted into the Union.  And while those events might serve to make a century’s worth of events feel close by, also consider that 1896 can feel very far away indeed.  A few other notable occurrences from that year:

William Jennings Bryan gave his famous “Cross of Gold” speech, looking to expand the nation’s financial system to accept silver as well as gold to underpin its monetary standard.  The age of print-what-you-need monetary policy would have been unimaginable.

 

New York State passed the Raines Law, which limited alcohol sales on Sunday to hotels.  Most workers only had Sundays off – a six-day workweek was the norm – so bars started to offer rooms for rent just to claim the hotel exemption.  You can imagine the results…   Unintended consequences indeed.

 

The U.S. Supreme Court ruled that States were allowed to segregate their populations by race under the “Separate but equal” doctrine.  The Civil War had only been over for 31 years – the same time span as 1982 to the present day.

Also born in 1896, and with us to this day, is the Dow Jones Industrial Average.  The brainchild of publisher Charles Dow, it was a tremendous advance in understanding the general direction of the U.S. stock market.  Essentially, Dow took a list of 12 prominent companies’ stock prices, drew a line at the bottom and added.  He tracked the result and published it in his stock newsletter, which grew up and became The Wall Street Journal.  With one number, Dow could describe the general course of trading over the day in a compact and useful form.

The Dow Average is with us to this day, and largely unchanged from its original form.  Yes, there are 30 stocks instead of 12, but there have only been 38 changes to the components in the Average since its formation.  It’s technically not an “Index” because of Charles Dow’s method of weighting stocks by price rather than market capitalization.  But despite the anachronisms and quirks, it is still the best-known measure of U.S. stock market performance going.  Ask most non-professional investors and people outside of Wall Street how the stock market is doing, and chances are good they will use the Dow Jones Industrial Average to answer the question.

That notoriety gives the Dow some power to shift popular perceptions of the state of the U.S. economy, and for that reason alone it is worth studying.  Layer on the recent Federal Reserve-induced volatility, and Charles Dow’s late-19th century invention becomes a 21st-century “Transmission mechanism” between Wall Street and Main Street.  Simply put, if the Dow swoons further you can bet the proverbial bottom dollar that the average citizen will notice.  And worry about their jobs, their house values, and (if they are fortunate enough to have one) their investment portfolios.

In the accompanying table we dissect the individual contributions to the overall gains in the Dow year-to-date for each company in the Average.  I am jotting this note in an airport outside Toronto, and my afternoon look at the Dow shows a 2013 gain of some 1,650 points, even with the swoon over the last few days. That’s still a 13% gain, but how did we get here?  And what does that tell us about the way forward?

 

Three points here:

1. Only 7 stocks make up the majority of the Dow’s advance in 2013.  They are 3M, Boeing, Johnson & Johnson, Home Depot, American Express, Disney, and Hewlett Packard.  Most of these names have middle-of-the-pack weightings (around 3-4%) with the exceptions of 3M and Boeing (5.7% and 5.2%, respectively) and HPQ (only 1.3%).

 

This math will change slightly for what will no doubt be a tough close today, but by our math these seven stocks have chipped in roughly 900 Dow points in 2013 out of the 1,650 total.

 

2. As Gilda Radner used to say on Saturday Night Live, “It’s always something”, so I don’t necessarily have a problem with a few names carrying a lot of the Dow’s water in 2013.  If it weren’t these, it might be others.  The real issue is that as you scan these names you’ll notice that they are, by and large, quite cyclical.  This economic exposure might be from individual consumers or large companies, but either way they do require a better macro outlook to generate meaningful earnings leverage.

 

3. The Dow is as top-heavy a measure of a major equity market as exists anywhere on the planet.  More than half the weighting sits at the upper end of the list we’ve appended.  The names you need to know are: IBM, Chevron, 3M, Boeing, McDonalds, United Technologies, ExxonMobil, Johnson & Johnson, Caterpillar and Travelers.  Yes, if you want to make a bull case for stocks you basically need to tell a good story about some of these names.  And it has to make sense with your global outlook, whatever it is.

The long and short of this discussion is as follows:

The Dow Jones Industrial Average is a concentrated and largely cyclical basket of stocks.  Most of its stellar performance this year comes from a handful of economically sensitive names.

 

Its longevity and brand give it inordinate weight in domestic consumer psychology.  Even if you don’t have a stock portfolio, you know your job is at risk if the stock market goes down too far or too fast.  Or both.  Professional investors and avid market watchers have some grasp of the reasons for this week’s volatility.  Nobody else will, and they will look at the Dow as proxy for their economic future.

 

The future performance of the Dow is levered to cyclical names as well, and most are average performers – at best – this year. 

 

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Sat, 06/22/2013 - 13:05 | 3682043 It is a bargin ...
Sat, 06/22/2013 - 13:11 | 3682049 CPL
CPL's picture

The Earls - Life Is But A Dream

http://www.youtube.com/watch?v=GawPha2RUHE

Sat, 06/22/2013 - 13:25 | 3682067 g'kar
g'kar's picture

My favorite tune, "My eyes glaze over only for you"

Sat, 06/22/2013 - 17:19 | 3682420 Pinto Currency
Pinto Currency's picture

 

When the bond market caves, the stock market will launch - but only a fraction of the increase of gold & silver (and oil, nat gas, etc.)

Sat, 06/22/2013 - 13:15 | 3682048 EclecticParrot
EclecticParrot's picture

The likelihood of a ZH headline quoting Neil Sedaka, or a lightning strike, which odds are greater ?

If you think the evidence at the top of this page favors a ZH answer, then you should, with the same logic, mortgage your house to purchase Mega Millions lottery tickets.

If, on the other hand, you chose lightning, but allow the possibility of synchronicity, then stay away from flagpoles and giant redwoods for the rest of the weekend.

 

Sat, 06/22/2013 - 13:19 | 3682056 lolmao500
lolmao500's picture

Well well well...

http://en.rian.ru/world/20130622/181809995/Russia-Offers-Iran-New-Replac...

Russia Offers Iran New Replacement for S-300 – Paper

Moscow made a new attempt to dodge a $4-billion lawsuit from Tehran over a failed deal to supply S-300 missile systems by offering another type of air defense system to Iran, Kommersant daily said Saturday.

The new offer on the table is Antei-2500, aka S-300VM, or SA-23 Gladiator in NATO nomenclature, the newspaper said, citing unnamed sources in the Russian arms trade industry. The missile defense system can simultaneously destroy up to 24 aircraft within the range a range of 200 kilometers or intercept up to 16 ballistic missiles.

The deal can be formalized during the visit of outgoing Iranian President Mahmoud Ahmadinejad to Moscow on July 1, an unnamed Iranian diplomat told Kommersant.

LOL... The S-300VM is even BETTER than what they were supposed to sell them... Russia is not fucking around anymore.

Sat, 06/22/2013 - 13:23 | 3682062 kliguy38
kliguy38's picture

Not too surprising....Russia is trying to play both sides.....without triggering DEFCON runup. What's funny is they'll get paid in gold while the peeps here get the bill from their gov

Sat, 06/22/2013 - 15:51 | 3682064 g'kar
g'kar's picture

Iran must be taking some advice from Valerie Jarret, after all she was born there from two ex-pat America hating parents.

Sat, 06/22/2013 - 13:25 | 3682066 BlueStreet
BlueStreet's picture

As Lucky Dube once wrote, 'Let The Band Play On.' 

 

 

Sat, 06/22/2013 - 13:35 | 3682076 Oh regional Indian
Oh regional Indian's picture

Excellent analysis, but meaningless in the broader context.

It's all rigged. Just do a search for Ming the Mechanic and DTCC.

ori

Sat, 06/22/2013 - 13:56 | 3682108 Cupid Stunt
Sat, 06/22/2013 - 18:31 | 3682573 g'kar
g'kar's picture

Weren't the Ori an omnipotent group of people that wanted to subjugate the humans everywhere so they would worship them as gods and increase their power through their worship?

 

Sounds familiar. (apologies to Stargate)

Sat, 06/22/2013 - 13:43 | 3682083 q99x2
q99x2's picture

Flat brain thinking. Where are the papers arguing for specific approaches toward future stability of civilization. I know we have analysis by Jung after WWII and can historically document how virtue was built into the laws of England to provide the basis for it to become a world empire and likewise for the US. But do we have a concesus among those with money and power on what virtues shall be the guiding force behind the future of mankind or is it simply whoever survives the destruction brought about be greed and the desire of psychopaths for power?

I ask this because there is a way that has been proven to work, there are the facts behind the functioning of the human psyche and there are those with money and power enough to bring those out of control forces back into line.

So where do I go to read about what is currently being offered as solutions to what is taking place?

Sat, 06/22/2013 - 13:51 | 3682095 put_peter
put_peter's picture

Reverse split bitzez!!!

Sat, 06/22/2013 - 13:59 | 3682110 DOT
DOT's picture

Dow weary.

Sat, 06/22/2013 - 14:25 | 3682148 DeadFred
DeadFred's picture

On May 31 some wise soul bought several million $ in puts on the DOW from 13500 down to 9500. He/she has a 60% gain so far.

Sat, 06/22/2013 - 14:48 | 3682184 DOT
DOT's picture

Nicely put !

Sat, 06/22/2013 - 13:59 | 3682112 Ribeye
Ribeye's picture

For the flippin love of the 1st Amendment,

Hello again my American friends (and NSA nerdgoons), I'm back,

Yep, you guessed it, banned yet again from politics.ie, dunno why yet, but I think it's coz I had the audacity to criticise your beloved president, and his magical wife, who was treated like a flippin Disney princess by the Irish govt and their media buddies. and fckn Bono and a few thousand airheads,

Anyway, I'm gonna have to hide out here for a while,

And I come bearing gifts,

She's a horrid socialist, but she said in this speech what a lot if Irish people were thinkin,

http://youtu.be/Ta7Av93ew2Q

Oh yeah, FCK YOU BERNANKE,

And you Geithner, we haven't forgotten about you ye little sh1t,

Sat, 06/22/2013 - 14:30 | 3682156 Kirk2NCC1701
Kirk2NCC1701's picture

Yeah, well, Boeing makes drones and HP makes printer ink and is the 'backbone' of the gubbermmint's "internets" backbone, and its blade servers farms, located in semi-arrid rural placed. Oh, and Cisco provides routers, etc. and we all know what MS does.

It all adds up to Big Bro and Big Ho.

Sat, 06/22/2013 - 14:37 | 3682169 Palladin
Palladin's picture

From it's inception the Dow Jones Industrial Average was a mathematical sham, and it still is today.

From a previous post:

The Dow, while quoted as an "average" but mathematically it really isn’t.

An Average is @sum divided by @count. And all of the items that are summed up must be of the same type. Inches of rain, times at bat, number of hits, runs scored, etc.

The notion that you can take the price of a stock, which is a variable, and can be any number greater than zero, and compare the price of one stock to another, then add all of the prices of the 30 variables up to come up with some sort of an average is mathematical nonsense.

It’s as if someone wanted up come up with a “Sports Average”, by taking the scores of one team in each of their respective leagues. One football team, one baseball team, one soccer team, one tennis team, one hockey team, one bowling team and so on until you get the number of points scored by 30 different Sports Teams on any one given day. Then total up all of the points and divide by the 30 teams and you then come up with a “Sports Average”. Any 10 year old kid can tell you that you can’t compare the number of points scored by a baseball team and a football team. Two different games, two different methods of scoring, nothing similar except it is a sports game, and they use a ball in both of the games.

Even more bizarre, the prices are treated as equivalent. The price of Chevron, has no relationship to the price of IBM. Both are in vastly different businesses, both have different total sales, head count, etc. They have virtually nothing in common, yet Wall Street has convinced everybody that somehow the price of Chevron and the price of IBM represent exactly the same thing from a mathematical standpoint. And Wall Street has also convinced everybody that the Dow is a good measure of what the "Market" is doing on any given day.

The Dow is in Wall Street terms, a “price weighted average”. Outside of Wall Street there is no such thing. As stated earlier, An Average is @sum divided by @count. Being a “price weighted average” means that a stock with a price of $50.00 will move the Dow twice as many points as a stock with a price of $25.00. It’s like saying rainfall on Tuesday counts twice as much as rainfall on Saturday. For example, if Alcoa (AA) is trading at 8.44 and if it went to zero the Dow would drop only 64.82 points. However, if IBM trading at $202.91 went to zero, the the Dow would drop over 1,550 points. So you can see that changes in the higher priced stocks change the Dow much more than the lower priced ones.

You might think the Dow Jones Industrial “average” is calculated by adding up all the prices of all the stocks in the Dow and then divide by 30. Well you would be wrong. It might have been true at some point in time, but that is not the case today. In fact, if you add up all of the prices of all of the 30 stocks in the Dow, as of 3/1/13, it equals 1,834.71. Then divide by 30 you come up with an average of 61.16, yet it is reported as being 14,089.73. You might ask yourself what accounts for this difference?

Over the years stocks have been added and deleted from the Dow and to compensate for these changes a divisor was created. This mystical divisor was created so that whenever any stocks were added or deleted from the Dow, the “average” would remain unchanged on the day the stocks were added or deleted (?). This makes little sense, since any changes in the stocks from that day forward will change the Dow.

Currently the divisor is 0.130216081 so if you divide the total of all the prices of all of the stocks in the Dow, 1,834.71 by the divisor, you will get the closing price of 14,089.73 as of 3/1/13. Technically it is a divisor, but in fact, it really acts as a multiplier.  From a mathematical standpoint, since the divisor is applied equally to all of the prices it could be any number and the percentage move would be identical. For example, if the Dow moved 2% one day and you were calculating the average the correct mathematical way, it would be 1,834.71 divided by 30 = 61.16 and a 2% increase would amount to an increase of 1.22 points in the average. However calculating the index using the current method would be 1,834.71 divided by 0.130216081 = 14,009.41. and a 2% increase would be an increase of 281.79 points.

Now what do you think the Financial Main Stream Media would like to report, an increase in the Dow of 1.22 points or an increase of the Dow of 281.79 points.  Both are the same percentage increase, yet the larger one carries much more physiological value than the smaller one.

So the Dow Divisor could be any number. It could be the official number of 0.130216081, or any other number greater than zero. Even though the Dow Divisor distorts the reported average by a factor of 230 it could be argued that from a mathematical standpoint it is a valid and accurate representation of  the average of the prices of the 30 stocks in the Dow.

But there still that lingering question of the mathematical validity of using the prices of the individual stocks to make up the average in the first place.

If you are interested in a complete discussion of how the divisor is calculated, follow this link: http://www.1728.org/dowjone2.htm

If you want a quick way to figure how each Dow stock will affect the overall average, just multiply the stock price change by 7.5.

For example, if CAT closes at 84.25 + 5.56 then the Dow point change would be 5.56 x 7.5 = 41.7 Dow points.

If you want to be super accurate, you can use the official divisor of 0.130216081. Using the example above the calculation would be 5.56 / 0.130216081 = 42.69 Dow points.

.

Sat, 06/22/2013 - 14:50 | 3682191 Lmo Mutton
Lmo Mutton's picture

Put the FED in the DOW.

 

That should fix it.

Sat, 06/22/2013 - 14:56 | 3682200 Satan
Satan's picture

QE5(2014) will include the Fed buying equities directly.

Probably more Goldman and Halliburton than Krispy Kreme and Lululemon.

Sat, 06/22/2013 - 15:55 | 3682300 Vince Clortho
Vince Clortho's picture

cause 'Breaking up is hard to do.

Sat, 06/22/2013 - 17:34 | 3682444 jon dough
jon dough's picture

...cause bakin' dope is hard to do...

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