My 1st Million At 33 – yes, you can do it too

A site to share my tips, tools, and humble thoughts on the journey to wealth

Legal disclaimer     Place your ad here    
  • Categories

  • Archives

  • Spam Blocked

  • Sponsors

  • Is Bull Market Back? On Dow Jones New Record High

    Posted by Frugal on October 11th, 2006

    I have read quite a few articles on why Dow Jones is not breaking its new high because on an inflation-adjusted basis, Dow did not exceed its 2000 high. That is all true, except on a the basis of technical analysis, I do not take such argument using inflation-adjusted curves. Technical analysis is rooted in human psychology, and human psychology on the numbers does NOT adjust price by what inflation has transpired. Therefore, I believe the fact that Dow Jones broke its 2000 high is significant by itself.

    But does that mean that the secular bear market is coming to an end? NO, not at all. Definitely not because of Dow Jones breaking new high, the secular bear market comes to an end. The most difficult question is which market index really represent the US market. Defining what the Market is is quite important from the perspective of asset allocation. At least according to Efficient Market Hypothesis, you should put your money according to the capitalization weighted percentage for every component. But what is an US stock market? Again, it cannot be represented by just 30 stocks which are not capitalization-weighted.

    Most people would say that either NASDAQ compositie index or S&P 500 are a good representation of the market, both of which are capitalization weighted. This I tend to agree. Both major indexes have not broken any new highs yet, especially NASDAQ which is still way under the 2000 peak. But probably a better index for the US market is the Wilshire 5000 or Russell 3000 index which represents close to 98% of all market capitalization, weighted based on capitalization. Both of the index have not broken any new highs either, but they are indeed quite close to the old peak. Wilshire 5000 had its peak back in 1999.

    wilshire5000_aol.gif

    And Russell 3000 had its peak on 9/1/2000 (1546.57, including dividends it’s 3140.09). Interestingly, if you look at Russell 3000 including its dividends, it actually has exceeded its old height on 5/5/2006 (value of 3168.85) and 10/5/2006 (value of 3223.4) (not including this week). So if you have invested in Russell 3000, you would have recovered ALL of your money by this time and some more. But the raw index value without dividends is still some 7% below its high. So what should one conclude from this?

    russell3000_2006.png

    My personal opinion is that dividends are cash distributed, and definitely for the purpose of portfolio balancing, you would not use the Russell 3000 value including the dividends. For the purpose of determining whether the index has broken a high, I tend to say that you should not include the dividends for the same previous reason. But for what it’s worth, you should be aware that the current high in the stock market is indeed quite amazing and slightly frothy too. In fact, if you look at the sub-components of Russell 3000, more specifically the small cap stocks of Russell 2000 (2000 smaller companies in Russell 3000), the small cap has broken new high noticeably. (Another reason to make sure your portfolio has small cap stocks weighting. History speaks up once more. Small caps outperforms.)

    russell2000_2006.png

    Although I’m still bullish on this market (in fact, if you follow my blog, you will see that I’ve put my own money into market and called at least 4 times for bulls since 8/16), I will be very cautious of chasing the market here. But the fact that there are quite many more bears around this time, it probably will make any dips to be shallow. I believe that the stock market will exhaust its momentum sometimes closer to the end of October to November. The dip may be slightly big, but it will make a big push towards next February to set up an even bigger fall. I have not made up my mind for 2007 to 2009, but temporarily, I am in the goldilock camp of a soft landing in housing market (but just for 2 more years) due to all the Fed’s printing press (of money). Soft landing would be quite unbelievable for all the bears. Yet the market can stay high longer than the bears can stay solvent. Certainly, the market likes to make the market high and long enough to squeeze all the shorts, while bringing on more and more last minute longs to make the final killing. This is always the norm, not the exception. Market overall will reduce the average return of all participants.

    If you are interested in studying indexes for your asset allocation, here are a list of all US stock indexes directly from Nasdaq. ML is running an asset allocation series, and my advice for investing $10K to $100K is asset allocation. Try to learn as much as you can, and if you have time, you should definitely read the two books (Four Pillars and Intelligent Asset Allocator) listed in my advice page above.

    The bear market seems to be over at the newstand. But let us come back to look at the truth after next January. It may be very interesting. Possibly market will present us another puzzle like with and without dividends for Russell 3000: will it be a new record high for the beginning of a secular bull market, or a new record high for the double top setup? Maybe it will be a cup and a handle. Who knows?


    More related posts:
  • Gold breaks record price (again and again)!
  • Fed Raise By Another 25 basis Point

  • Digg it Del.icio.us Reddit Furl BlinkList Newsvine Yahoo MyWeb

    8 Responses to “Is Bull Market Back? On Dow Jones New Record High”

    1. NLG Says:

      This post sounds interesting, but I only comprehend a small portion of it. Some of the statements are somewhat vague, and I am not sure what you’re talking about. I can see that you know this like the back of your hand, but for me, I need this spoon fed as though I don’t know anything about stocks.

      “Soft landing would be quite unbelievable for all the bears. Yet the market can stay high longer than the bears can stay solvent. Certainly, the market likes to make the market high and long enough to squeeze all the shorts, while bringing on more and more last minute longs to make the final killing. This is always the norm, not the exception. Market overall will reduce the average return of all participants.”

      NG

    2. Ray Says:

      I think that 2007 will be a HUGE Bull Market, I’m not sure how it plays out in to ’08 and ’09. I would say most people use the S&P 500 as the standard benchmark for looking at the market. Even with the higher interest rates, and even with the possibilty of profits being down at larger companies, that is offset by lower P/E multiples than ever before. With the avg P/E of around 17-18 on the S&P 500, that in itself should indicate huge bargains in Blue Chips. I wouldn’t shy away from the Russell, but I would place a much larger position in Large Caps than in the previous 5-7 years.

      I’d personally like for the market to come down as I have many years ahead of me to invest and I’d like to get more money in at the lowest cost average.

      On another note, I think I’m going to invest in the BRUFX fund which was recently rates A/A in an up or down market.

    3. Frugal Says:

      NLG,
      By that paragraph, I meant that when market goes high, people who short the stocks will sustain a lot of losses. Since the potential loss from shorting stocks can be unlimited, they can go bankrupt if they don’t cut their losses short.

      Not sure if the following post will clear it up a little on the last 2 sentences (maybe it will make it more confusing?):
      http://www.1stmillionat33.com/2006/09/why-investing-hypes-never-work/

    4. Frugal Says:

      Ray,

      A P/E of 17 to 18 is still high by historical standards. Historically, P/E is more closer to 13 to 14. There are many valuation models, but I usually use treasury bond market as my measure. At 5% bond yield plus 1.5% to 2.5% risk premium, the stocks should yield at about 6.5% to 7.5%. Translating that back into P/E ratio, it’s about 1/6.5% or 1/7.5% which is , it’s equivalent to P/E of 15.4 to 13.3. Therefore, a P/E of 13.3 to 15.4 is probably okay. Since this calculation doesn’t account for growth rate, it’s under-estimating the P/E (in the absolute number).

      At the bottom of a big bear market, average P/E falls to about 7. That has not happened since 2000. Maybe it will not happen. But I won’t rule it out yet.

    5. NLG Says:

      Thanks for the reply Frugal. It makes more sense reading it a second time.

      NG

    6. Ray Says:

      Frugal,

      I will agree with you to an extent. We just came out of a low interest rate period. During periods of low interest rates P/Es are higher due to the cost of capital being lower. Since bonds are low, investors like to own equities, which would fuel even higher P/Es. The historical average is around 15 from my investigation. With the rise in interest rates as of late, I think you are going to see the P/E rates continue to lower as corporate profits shrink because of the rise of rates. P/Es are just one way to look at companies and I wasn’t totally relying on that for my assumptions, but more to say that P/Es of large cap stocks are more inline with historical averages and since the trend long term has been toward small-cap stocks, the next run will be the large cap sector. This is why I see ’07 as being a great year for the S&P 500.

    7. Frugal Says:

      Right now, I will definitely choose large cap now over small cap. We certainly agree on that point.

    8. Ray Says:

      Hey that’s all that matters =) I’m not taking the contrarian position anymore, as I think the pendulum has swung and the future is bright. Enjoy your weekend.