Rearranging Deckchairs on the Titanic

October 28, 1999

I have been affiliated with Wall Street more years than I care to remember. Consequently, I felt until today I had already seen everything -- all the possible tricks and shenanigans the securities industry could invent to deceive the investing public. WELL, today I learned a new one!!

Yesterday's action was far more audacious and outrageous than I thought Wall Street would ever dare perpetrate. It was announced late in the day that the components of the Dow Industrial Index of 30 stocks would be "revised." Four components of the Dow would be replaced with four new stocks.

Specifically, it was announced that starting next week, the following four stocks would be dropped from the index, which heretofore was the barometer most accepted by investors globally to measure the US market's health. Chevron Corporation, Union Carbide, Sears and Goodyear Tire will be dropped - and replaced with Microsoft, Intel, Home Depot and SBC Communications.

As expected there was an immediate news barrage to justify the change in an effort to MANIPULATE public opinion BEFORE it had time to digest and analyze the ramifications of the disguised distortion. There was talk that the new mix "better" represented today's market. That the old 30 was too archaic. That the more "streamlined" index was better designed going forward… that this and that that…

Before I provide MY personal opinion on Wall Street's real motivation in warping the Dow Index, allow me to present some comparative data for YOUR CONSIDERATION AND EVALUATION.

A Stock Index

Most objective market students believe a stock index should be a representation of a universe of stocks: a simple gauge or reference which is used to measure the ups and downs of thousands of stocks. Possibly the most popular stock market guide (index) in the world ever created saw the light of day in 1896. Although the Dow's original design was composed of many stocks, it was in 1928 that the powers to be decided that only 30 stocks were sufficient to represent the universe of publicly owned companies, which represented industrial America. Moreover, there were three separate Dow Indices reflecting the Industrials, Transportation and Utilities Groups. It was understood that if the Dow was up 20%, one might correctly assume that on-balance all listed industrial stocks were on average up 20%. This implies the valuation factors of the Dow components were similar in magnitude to the average of all industrial stocks.

Let's look at the primary fundamental valuation methods, which most competent analysts take into account when comparing various stocks. In fact let's compare the valuation techniques of the new Dow components vis-a-vis those of the four Dow "dogs" (i.e. stocks being kicked out of the Dow index). Symbols of the new components are MSFT, INTC, HD, and SBC (the 'Fabulous Four) - and the old ones are CHV, UK, S and GT (the Dow Dogs).

New Components
Stock 5-year Gain PER Div Yield
MSFT
INTC
HD
SBC
+1,050%
+800%
+318%
130%
61
34
55
21
- 0 -
0.17%
0.23%
2.14%
Average: 575% 43 0.64%
    
Old Components
Stock 5-year Gain PER Div Yield
CHV
UK
S
GT
96%
79%
23%
17%
55
28
8
21
2.77%
1.53%
3.41%
2.91%
Average: 54% 28 2.66%

Observations

  1. Since the beginning of the century, stocks have appreciated on average 9% per annum. Nevertheless, the last five years have witnessed an exaggerated stocks' appreciation not seen since the Roaring '20s, when stocks also soared with IRRATIONAL EXUBERANCE. And although many stocks have increased in value about 20% yearly in the last five years, by no wild stretch of the imagination can any honest person suggest this will continue ad infinitum.
     
  2. Undeniably, the 'Fabulous Four' induced a strong bias into the Dow index - NOT representative of the market in general. Please take critical note the 5-year performance of the 'Fabulous Four' was MORE THAN 10 TIMES that of the four Dow-Dogs (575% vs 54%).
     
  3. Whereas the average PER of the Dow is about 28 times, that of the 'Fabulous Four' is 43 TIMES!!!!!!!!!!!
     
  4. The disparity in dividend yields is even more divergent. The 'Fabulous Four' dividend yield is 76% LESS THAN the Dow Dogs, and even 63% LESS THAN the entire Dow Index today.
     
  5. The Internal Rate of Return of the Dow Dogs in the last five years was 9% per year - whereas the 'Fabulous Four' demonstrate the stellar results of a 47% Internal Rate of Return -- FIVE TIMES THAT OF THE Dow Dogs.
     
  6. No reasonably objective person would dare suggest the 'Fabulous Four' will make the Dow more representative of the stock universe. No way Jose!
     

CONCLUSIONS

It does NOT take a brain surgeon or a rocket scientist to ascertain the Dow's planned mutation is designed with one goal in mind. Wall Street well knows the stock market is in a BEAR MARKET MODE… and will most probably continue so until all excesses have been wrung out of obscenely over-valued stocks (even per Greenspan: "...stocks are over-valued by at least 40%"). In effect, the Dow has had its "face lifted" to falsely hide its age!

Consequently, the Dow's composition was altered to purposely skew results to avert the appearance the market is sinking into the sucking-down quicksand of a Bear Market.

But, it is done. We now have a "new" Dow. However, it cannot alter the terminal prognosis for the elderly patient. The 'ancient graying-man' (Dow) has been diagnosed with age related illnesses. And regardless how much the "doctors" dye his hair and pump him with stimulating drugs to artificially increase his adrenaline flow, THE PATIENT WILL SOON DIE… the "cosmetic doctoring" has only delayed the patient's period of agonizing.

Founder of Gold-Eagle in January 1997.  Vronsky has over 42 years’ experience in the international investment world, having cut his financial teeth in Wall Street as a financial analyst with White Weld. Vronsky speaks three languages with indifference: English, Spanish and Brazilian Portuguese.  His education includes a degree in Petroleum Engineering from the University of Oklahoma, a Liberal Arts degree from Hartnell College and a MBA in International Business Administration from UCLA – qualifying as Phi Beta Kappa and Tau Beta Pi for high scholastic achievements.  Vronsky believes gold and silver will soon be recognized as legal tender in all 50 US states…and many countries worldwide.  You may reach I. M Vronsky at: vronsky@gold-eagle.com and/or vronsky@bellsouth.net

Pure gold is so soft that a strong man can squeeze it and shape it.