Dow 13,000 is a big number, but it's just a number
Monday, February 27, 2012
Big, round numbers are hard to ignore. That's why we pay attention when the odometer clicks over to 100,000 miles, and why the world threw a party at the dawn of 2000 instead of the technical start of the millennium in 2001.
It's no different on Wall Street. When the Dow Jones industrial average briefly crossed 13,000 last week, a milestone it hadn't reached since before the financial crisis, people took notice.
Some observers said it was a sign of a stronger U.S. economy. Casual investors wondered whether it was time to get back into stocks after fleeing to bonds or just stuffing their money under the mattress in the terrifying economic meltdown.
But a word of caution: 13,000 is just a number.
It gives politicians something to talk about. It gives regular people something to measure against. It can stir up excitement, but it doesn't change the elements of the economy, like the number of people out of work or the number of empty houses.
The Dow also isn't the best measure of the stock market. It follows 30 companies — important ones, household names, but only 30. And it's weighted so just a handful of the most expensive stocks carry the most weight.
If Apple, whose stock has skyrocketed this year from $405 to $522, had been added to the Dow on Jan. 1, it would already be above 14,000, according to estimates last week from ConvergEx Execution Solutions.
And the Dow is certainly not the best measure of the economy. It can rise even when jobs are falling or the economy is shrinking.
"Psychologically it matters," says Dan McMahon, director of equity trading at Raymond James, who was underwhelmed by the Dow's short foray above 13,000 last week. "Technically and fundamentally, not so much."
It's the same mind game when people turn 40. They're only a day older, but it feels more significant. Retailers understand this trick, too. That's why they slap $99 on a price tag instead of $100. That one dollar feels like a lot.
For the Dow, "whether it's 12,999 or 13,000 is just arithmetic," says Mark Lehmann, president of JMP Securities in San Francisco.
Keep in mind also that the market is a fickle barometer. Some institutional investors, such as hedge funds or private-equity firms whose employees follow the market for a living, will consider the 13,000 mark a signal to get out, not in.
And 13,000 may not last. The fire-sale discounts for stocks appear to have come and gone. The companies that make up the Dow are trading at about 13.9 times their past year's earnings per share, a popular measure of how expensive stocks are.
Just last month, that figure was 13.2. At the Dow's low during the Great Recession, it was 8.2. So the Dow is approaching the average of about 16 over the past two decades, according to Birinyi Associates, a stock market research firm.
And though this sounds obvious, it can be hard to remember in the headline rush of 13,000: You want to buy stocks when prices are low. The stock market is perhaps the only place where shoppers rush in when prices go up.
"Human beings are pattern-seeking animals," said Brian Gendreau, market strategist at Cetera Financial Group. "We find patterns even when there are none."
The Dow has climbed back slowly since its 2009 low of 6,547.05, and its other milestones have also generated a frenzy of attention. But as motivations for investment, their record has been mixed:
— On Oct. 14, 2009, about 10 years after the first time the Dow hit 10,000, the average hit the mark again. Traders passed around baseball caps labeled "Dow 10,000 2.0" on the floor of the New York Stock Exchange.
Mutual funds didn't think the milestone was a good time to invest: They pulled $216 million out of U.S. stocks that day, according to TrimTabs Investment Research. A week later, the Dow was down about a half-percent. Three weeks after that, though, it was up 2.7 percent from its Oct. 14 close.
— On April 12, 2010, the Dow crossed 11,000. This time, the Dow climbed in the following week, up 0.8 percent. Three weeks after that, it was down 2 percent.
— On Feb. 1, 2011, the Dow crossed 12,000. A week later, it was up 1.6 percent. Three weeks after that, it was virtually flat.
Experts say investors should keep in mind that the surest way to profit in the stock market is to invest for the long term. Buying for just a week or a month at a time is a risky bet.
Beyond talk of milestones, there's also the question of whether the Dow is even an accurate measure of the economy. Besides being made up of just 30 companies, it's weighted so that the few with the highest stock prices carry the most heft.
So a small percentage change in the stock of IBM, which is trading around $198, sways the index much more than a large change in the stock of Bank of America, which is trading around $8.
Last year, the Dow rose 5.5 percent. But strip out IBM and McDonald's, the two stocks with the highest prices last year, and it rose just 1.8 percent, according to calculations by Birinyi.
Plenty of analysts say the Standard & Poor's 500, given its much broader list of companies, is a better measure of the market. While the Dow would need a 9 percent rally to reach its all-time high of 14,164.53, the S&P 500 is still 15 percent away.
It did close Friday at 1,365.74, a 3 1/2-year high and about 200 points from its all-time high in October 2007.
"The Dow has only 30 members," says John Manley, chief equity strategist for the Wells Fargo funds group. "Sometimes their individual stories bury the message that the economy is trying to send us."
So in a way, it will be a bigger deal if the S&P breaks 1,400. But nobody makes baseball caps for that.
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