The Dow Jones All Time High
The Dow Jones All Time High
The Trader's U E-Letter: Issue # 187
Wednesday, May 10, 2006
The Dow Jones All Time High: What NOT To Do As the Dow Approaches its Record Peak
by D.R. Barton, Jr., Chairman, Trader's U
I stepped into a well-known sports bar in my hometown of Newark, DE, to order a quick sandwich. The lunch crowd was made up mostly of guys sitting at the bar and at tables.
I looked up for a casual glance at the TV and what I saw made me do a double take
The TV in the sports bar was not tuned to ESPN. It was showing CNBC, the financial network.
If you haven't already guessed, this was in February of 2000, and signs of a frothy market were everywhere: Waiters giving stock tips. Time and Newsweek running cover stories on the basic theme of "Aren't you rich, yet?"
And, of course, patrons of sports bars watching Bill Griffith on CNBC's Power Lunch.
Those halcyon days of "Nasdaq 5000" seem like light-years ago. But here we are in the spring of 2006 and the Dow Jones Industrial Average is within spitting distance of its all-time highs.
That's right - the Dow Jones all time high. As I type these words, the cash index (as opposed to the futures contract that is traded) is sitting at 11653 - less than 100 points from the highest point in the history of the Dow (which happened to be 11749.97).
Before we go further, take this little personal market history quiz. See if you can remember:
- How far the major indices dropped from their highs to their lows,
- What percentage they have moved up from their lows,
- What their current price is, as a percentage of their highs.
We'll look at the Dow, S&P 500, Nasdaq Composite and Russell 2000 indices.
As the stock market tries for new highs, I felt compelled to look at what was happening with all the widely followed indices. The results were an eye-opener with some great lessons. But most importantly, looking at what has happened in the equities market over the past six years gives us some clear direction for what we should be doing now.
A Tale of Two Markets - One Up and One Down
Everyone who follows the market knows that it peaked in early 2000. The Dow Jones actually hit its previous all time highs in January (1/14/00) while the other indexes peaked in March. The Nasdaq Composite and the Russell 2000 hit their highs on 3/10/00, while the S&P 500 topped out on 3/24/00. (The Russell 2000 is the best known and most widely followed small capitalization index.)
The big drop that followed is now either legendary or a painful memory, depending on how your assets were allocated during the tumble.
All of the indexes bottomed in October of 2002, and since then, we have had a 3 1/2 -year bull market.
But what struck me about this stock market historical data was the difference in how the indexes have moved since their highs in 2000. Here's a look at the raw numbers:
(Editor's Note: The Nasdaq number should be 5132.52 in the High Column)
What stands out here is that while the Dow has almost returned to its high, the index that is the most unlike the "blue chip" Dow, the Russell 2000, has outperformed all others by a large margin and is currently trading far above its year 2000 highs.
Let's look at things from a percentage basis:
While the Dow is less than 1% from its all-time highs, the Nasdaq composite is still more than 50% below its year 2000 valuation. And I'm sure you know someone, like I do, who is still holding one of the tech stock darlings from back then, hoping and praying that it will return to its glory days!
For the visually oriented folks out there, you can see a visual representation of these data in "The Chart of the Week" section below.
Nice History Lesson on the Dow Jones But What Can I Do With It as an Investor?
We could pontificate about many lessons here, but let's look at two practical things that you can do in your portfolio now. But first - what NOT to do - don't get complacent! New highs in the Dow are great, but they also attract institutional money looking to bet that the highs will hold, especially on the first try to break though. On to the action plan:
- Have a plan that lets profits run, but gets you out if prices head south. As traders and investors, we need to let our profits run. This means not bailing out of long-term positions with every market wiggle. At the same time, don't hang on too long if the market starts selling off significantly in the months to come. Our lesson from 2000-2002 is that the market can do serious damage to a portfolio that doesn't have an exit strategy. The trailing stop (like the 25% trailing stop that The Oxford Club endorses) is the best way I know to let profits run while protecting against catastrophic moves.
- Understand the value of diversity. While the Dow didn't fall as far, it also has been slower coming off its lows than its rival indices. Having some blue chip and some smaller caps in tow (or just the whole index) makes some good portfolio management sense, regardless of your overall investment strategy.
Today's Trader's U Tips & Tricks
- Advanced Trader's U: To brush up on some trading tactics, browse through the thoughts of the market's masters: Market Wizards: Interviews with Top Trades, by Jack Schwager, features the concepts of Ed Seykota, Dr. Van K. Tharp's thoughts on trading psychology, and find some key threads that run through the conversations from all of these great minds. You can find the book here.
- Also by Schwager, New Market Wizards is an extension of the first book with more great interviews and, as an added bonus, has a summary of the lessons from all the interviews as a last chapter.
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The Chart of the Week
Major Indices, Percentage Change From March 2000-May 2006. On the chart, the percentage numbers are different than those in the table above since the indices all hit their highs on different days. For example, since the Dow Jones all-time high hit two months before this chart begins, it shows a higher recovery percentage.
- S&P 500 Performance: The Index Has Been Strong, But How Much Longer Will It Last?
- Nasdaq Forecast 2006: Actions To Take When the Market Gives Us Multiple Signals at the Same Time
- The Stock Market Tries for New Highs: Use Caution When Investing