This article is going to argue two points which can not readily be taken from any chart. The first is that the market is in a bottoming process (particularly in the US) although the view from the chart is somewhat clouded. The second point is that the financial sector is heralding the start of a recovery (particularly in the US). Although these points are at first easy to dismiss with the levels of doom and gloom currently dominating, a closer investigation should actually have a positive impact for investors and bullish traders alike.
If the market has actually bottomed, why is the Dow still making new lows? The Dow Jones seems to have become a synonymous barometer to the economic health of the entire world, yet the index most people follow (the DJ Industrial Average) is made up of only 30 companies. The Dow is also a price weighted index, meaning that big depreciations in the price of higher priced shares will have an unequal impact on the overall index. For example, a rise of $1 in a company with a low price might represent 20% appreciation, but will have no effect if a company with a share price of $100 falls by $5 (only a 5% drop).
3 companies in the Dow 30 are all now household names for all the wrong reasons and have been acting as a huge burden on the other constituents: Citigroup (down 98%), GM (down 96%) and Bank of America (down 94%). These once highly priced shares dragged the Dow south, however, any subsequent big percentage increases in their price will have little or no effect on the index. One way to improve the performance of the Dow overnight would be to revaluate those constituents, kick out the bad performers and put in some of the new industries which are a more relevant representation of the US goliaths. If a recalculation was performed to include Apple and Google would investors feel the economy worries lift with a 1500 point overnight rise in the Dow?!
The second point to make refers to the observations that financial companies have led the market out of most bear periods this century. A glance at the financial sector in the US (DJUSFN) looks horrendous, although some consolation can be taken from what appears to be the formation of a potential fifth (and final) wave down.
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The real truth of this chart might well be hidden by influence of some severe and well publicised financial institution collapses. With Lehman’s, Bank of America, Citigroup and Merrill’s all contributing to the decline it is easy to overlook “some other” performers in the investment bank space. I have put the words “some other” in inverted commas although it’s probably fair to say the “only other” investment banks (Goldman Sachs, Morgan Stanley and Credit Suisse)!
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So what conclusions can be drawn from this information? Realistically, the falling tide does indeed lower all boats, however, if you expect the ‘bottom’ to simply occur on one day, you may be mathematically correct as a future or index trader, but wrong as an investor. Despite the new lows in the Dow and S&P, I will wait to see a break of the November low on some of the midcap growth indices (DJUSGM.CBOT for example) before I am convinced we are NOT already in a bottoming process . Does this mean the markets will rebound sharply? I suspect that they will, however risk does remain that the recovery will be slow so prudence errs on the side of considering fundamentals. Time, of course will tell, although an investor should really be putting money into the market as per Andrew Page’s www.dividendkey.com suggestions.