The Irrelevant Industrials?

February 26, 2012

With the 'breaking news' on Tuesday morning being the fact that the Dow Jones Industrials had broken 13,000 for the first time since 2008, the immediate spin from the majority of the mainstream press revolved around 'see, its all better now'. Their evidence for this ridiculous statement? The performance of 30 stocks and an index that changes more than a flip-flopping politician during campaign season.

And exactly what is the justification for all the hoopla? Well, it seems we are in fact back to the idiotic notion that the performance of the stock market somehow represents the economy as a whole. Let's take a look at some things, shall we, and see if this really passes a rather simple, non-economic test: common sense.

Share Volume

In my firm's now quarterly publication, we have studied price-volume divergences and convergences in great detail. One thing has become very clear since the 'end' of the crisis of 2008 and that is the fact that the 'little' guy is out of this market for the most part. I pointed out many days where Citigroup and Bank of America trading alone would be responsible for upwards of 60-75% of the total trading volume on the New York Stock Exchange. Granted, there are other exchanges, and this phenomenon existed in other places as well. How anyone could say that the movement of the shares of two banks is somehow indicative of the macroeconomic health of this nation is beyond ludicrous.

Here's a quick (both recent and random) example. On Monday, February 21, 2012, Bank of America's volume was around 355 million shares. Citigroup kicked in another 23 million. Keep in mind Citigroup underwent a 10:1 reverse split in March of 2011 to give the illusion that a nearly worthless stock was in fact worth something. Still, let's play out the example. These two accounted for 378 million shares worth of volume on a day when total NYSE volume was around 897 million shares. Those two companies accounted for 42% of NYSE volume on what was a very unremarkable day in the markets.

Another interesting phenomenon has been the general decline of volume in general. For the longest time the DOW/S&P500 were making gains on weak volume days and taking losses on days when volume was higher (P/V Divergence). Aside from the fact that this type of action typically portrays a very unhealthy market, it also showed a near complete lack of interest/conviction on the part of buyers. Economic optimism was down the tubes (and still is, comparatively speaking) and the unemployment rate was still going up. Not exactly prime ingredients for a bull market.

Probably the most interesting point that can be made about this whole situation is the perception that the 'market' is the economy. Let's take a look at how things have changed. Decades ago, when America was primarily a manufacturing power, it made a good deal of sense to have an 'industrial index', comprised of the biggest and most powerful of the industrial companies. The logic at the time was simple. If the economy was doing well, those companies were doing well, earnings were going up, etc. It was an easy concept to follow. The health of the economy as a whole and the industrial companies were fairly closely linked. Sure, there were periodic dislocations as share markets are prone to quick blow offs and bottoms, regardless of whatever else may be going on. But by and large, it made sense to connect the health of the market with the health of the economy.

Industrial Average - Really??

Fast forward to today. 5 of the 30 components of the Dow Jones 'Industrials' average are either banks or insurance companies. Nothing industrial there. 3 are essentially retailers, and there are at least another 7 who are nothing more than peddlers for goods made in China or some other place that only throws our current account further out of kilter. So we can easily make the argument that half of the 'Industrials' index is either anything but or has absolutely nothing to do with American industrialism. It used to be worse; AIG was a member of the Dow 30 until it disintegrated a few years back.

Which brings up another interesting point. Granted, companies come and companies go, but there is a good deal of shape shifting that has gone on over the years within the Dow Industrials 'Index'. I don't have the empirical data on what this average would look like if it would have been left as it stood back in 2000, but just taking a look at some of the companies taken out and some of the ones added, it would seem to be a good bet that we might be talking 10,000 rather than 13,000.

Let's list some of the more recent changes. AIG was removed by 9/22/2008 after absolutely crashing thanks to the now well-known scandal. By June 8, 2009, Citigroup was gone, also a 'victim' of the great crisis of 2008. These two were replaced by Kraft Foods and The Travelers Companies. Ironically, Kraft is up over 50% since it was added. Guess what? So is Travelers. AIG is essentially under Federal Reserve receivership, and Citigroup is a mere shell of its prior self - let's not forget the aforementioned 1:10 reverse split. The point here is simple. Where would the Dow 'Industrials' be if we hadn't pulled AIG and Citigroup and put in two much better performers? The answer is it really doesn't matter because the index, for the most part, is irrelevant anyway. There are folks who have done a great deal of research and have come up with all sorts of conclusions on the validity of the Industrials Average in terms of where it should/would/could be and all that good stuff.

The bottom line here is that when you turn on the evening news and they get to the economy, the first thing you hear about is the stock market and you get to see the Industrials, the NASDAQ, and the S&P500. There are either green arrows or red ones. There might be a blurb about a jobs report or consumer confidence or some other measure, but by and large the impression most people seem to get is that as long as the 'markets' are going up, things are well in the economy. While this notion wasn't exactly correct back in the day when we were still an industrial nation, it certainly isn't the case now. Especially when megabank computers shaving pennies from each other constitutes such a large percentage of 'investment' activities.

Andy Sutton is the Chief Market Strategist for Sutton & Associates, LLC – a Registered Investment Adviser in Pennsylvania. His focuses are econometric modeling and risk management. The firm specializes in wealth preservation and growth and recognizes the validity of non-paper assets in achieving a balanced approach. The firm is also currently working with a growing clientele towards avoiding the risks outlined above.

The King James Bible mentions gold 417 times. Not once does it mention a paper currency.

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