Life experience has taught us that history is often quoted but rarely remembered for its context. We are fielding questions regarding the value of equity indices and their appropriate levels less than one year after the calamity of last fall. Understand that in the short-term, rarely do market valuations matter as much as market sentiment. Additionally the yardstick of today is not the one of yesterday and most likely won’t be the one tomorrow.
Market sentiment is the attitude of the investing collective – professional and private – buying and selling equities on any given day. Many scientific and even straw polls are taken to see how the various investor groups feel at any given point in time. The equity market is perhaps the greatest example of self-fulfilling prophecies!
In early March of this year professional asset managers were collectively bearish on the market, the economy and their own family reunions. Nothing was good and it was getting worse. The market followed suit by going down. The sentiment was deplorable.
As the “first responders” to value investing showed up in March the market began to climb – only after everyone who was willing to sell had already raised the white flag and sold. Slowly but steadily the sentiment improved. Today we find market sentiment on the bullish side near 90 percent; meaning that 9 out of 10 professional asset managers believe the market goes higher from here. That will remain the case until everyone who is going to buy has bought and then you will see the game that started in March begin to reverse.
As we hear the media reflect on market sentiment, they talk about the history of the equity markets accurately but without the full context of the surrounding reality. There are changes made inside of the indices for various reasons. Some are booted out for poor performance or changing economic times. Rarely – if ever – has a well performing company been removed from either the S&P500; or the DOW Jones Industrial Average.
Here are some recent changes: Hewlett-Packard, Johnson & Johnson, and Wal-Mart joined the average, replacing Bethlehem Steel, Texaco, Westinghouse Electric and Woolworth in 1997. Home Depot, Intel, Microsoft, and SBC Communications joined the average, replacing Union Carbide, Goodyear Tire & Rubber, Sears, and Chevron in 1999. American International Group, Pfizer, and Verizon joined the average, replacing AT&T;, Eastman Kodak, and International Paper in 2004.
Short-term you can use the yard stick as a measuring tool of recovery but if you step back you will realize over any length of time the tool is nothing but a merry go round looking for the hotter stocks of the time. Norman Fosback uncovers these issues dating all the way back to the Great Depression. IBM was removed in 1933 and not added back until years later. Had the change not been made, Fosback’s research shows the DOW would be twice the level as it is today. A study showing the years of recovery for the DOW from 1929 is interesting but incomplete. This is why we urge you to think more about what your savings means to your financial plan and well being than it does compared to a benchmark that has some obvious human touches.
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