Is the Dow Jones Industrial Average really a good indicator of the stock market's future?
This column has—upon several occasions over the past years—taken the opportunity to pass on the thoughts of Vern Myers, whose newsletter (Myers Finance & Energy) is among the most widely respected of the "alternative" economics publications. And, following the recent dramatic movements in the stock market, we've noticed that the more traditional commentators—be they speaking on television or radio, or writing in newspapers or business magazines have taken to discussing the Dow Jones Average as if it were a creature with an intelligence of its own, and one that could decide to bless investors with fortune or damn them with ruin at any given moment. Well, with that sort of attitude going around, we thought it might be valuable to take a look at just what the Dow Jones is, and where its "intelligence” comes from. To do so, we've turned to the work of Vern Myers once again, and are pleased to offer this essay from the June 10, 1983 issue of his newsletter. The article cited below has been reprinted with the permission of Myers Finance & Energy.
Great numbers of analysts will tell you that the Dow Jones is the infallible prophet of what is coming up in the economy. This is another one of those axioms that is accepted without much thought and with practically no analysis.
The idea ought to be examined from three standpoints. (A) What happened the last time the Dow Jones predicted a booming economy? (B) Just what is the Dow Jones? (C) What are the components of the Dow Jones?
The rising Dow Jones of 1929, according to its disciples, had to be predicting that they were running into a great accelerated economy—that the decade of the thirties would be the economic bonanza of all times.
Well, it didn't happen. In fact, the opposite happened.
What is the Dow Jones made up of?
Well, it is made up of 30 so-called industrial blue chip stocks. Those are the companies that produce the industrial guts of America. They are the giants in autos, steel, computers, chemistry, appliances, etc. All of the quotations of the price value of these corporations are worked into an index. This index changes daily as the prices change, and the index is a composite of what all of these corporations are doing collectively on the free marketplace.
What are the component activators of the Dow Jones Average?
The components are the buyers and the sellers of the marketplace. John Jones is selling. Jack Smith is buying. One bank is selling. One bank is buying. A mutual fund is jumping in. Another mutual fund, observing that, also jumps in. After three or four have jumped in, the entire flock of sheep is jumping in. That is part of the components of the Dow Jones.
The Dow Jones is composed of buy and sell orders around the world from Zurich, England, France, Italy, Saudi Arabia—everywhere. It is a huge composite photograph of every transaction ventured on a particular day.
To come up with the infallible prophecy, the chartists now transfer these daily actions onto charts. After a while the charts begin to make a pattern. Eventually a rising Dow Jones, covering an unspecified amount of time, but climbing fast enough to create excitement, begins to convince all the followers of the Dow Jones that a bull market is underway.
Now the astute observers apply the inevitable logic. If the Dow Jones by the rising quotations on stocks is predicting a great advance in the economy, that naturally means that the earnings of these companies are going to be perhaps dramatically higher, and therefore, if one buys the shares today, he will be able to sell them at a very much higher price later on because the new increased earnings will naturally justify the new price. And there you have it.
But there is a very naughty question involved.
First of all we must ask, did any one of those buyers on a particular day have any real knowledge of what the general market was going to do, and was his knowledge of a particular stock which he bought anything more than a guess? Now when this fellow bought, there also had to be another fellow who sold. Now was this seller a bit wiser than the buyer and did he have real good reasons to believe that the earnings of that particular stock were going to go down?
In other words, if you took all of the activators of the Dow Jones in a single day, could you pick out any single one of them and say that he knew what the hell he was doing any more than his counterpart (buyer or seller) knew what he was doing—or any group or groups?
In other words, did these components in total know any more about the future than you know?
Now if there was no great wisdom in the majority of the components who acted to buy or sell, then how did it come that taken collectively they produce a gem of wisdom?
Taken individually, they know very little. But taken collectively, they are sages?
Does that make sense?
Since 1966 the Dow Jones had been fluctuating through an area of about 300 points—700 to 1000—in wave after wave. Each of these was called a new Bull Market. Yet not one of these over the course of 16 years produced a market that was noticeably higher than it was in 1966.
Now I don't claim to be any wizard. But I have been around and involved in the market in various ways since 1947, a third of a century. I've looked at a lot of charts. I've listened to a lot of brokers. I've read a lot of economists. I've seen some fortunes made, but I have seen more smart guys get their comeuppance in the market than anywhere else. Mostly they get it because they accept one or other line of thought as being a reliable gauge of what is going to happen. The worst of it is, it sometimes works. That is usually unfortunate for the novice. This initial success gives him confidence. But the next time he plunges through a door that he opens with this key, he finds himself falling down an elevator shaft. He never thought a single key could lead him into two diametrically opposed positions, the one door going up to fortune, the other into an abyss.
Now in 1928, and especially the first eight months of 1929, the Dow Jones charts were registering the action of the greatest Bull Market in living memory. Was that chart foretelling the great economic gains of the future? Almost everyone thought so.
Today the Dow Jones has turned into a Bull fully as fierce as the 1929 Bull. And people are going for it hook, line, and sinker. Hardly an analyst remains Bearish today.*
Well, as the 1929 Bull turned out to be nothing more than a huffer and a puffer, is there great reason to believe the fierce Bull of 1983 is a more awesome prophet of a great economy now building?
The debt under-structure of 1929 and 1983 are highly similar.
I think it is very poor business to take any one theory very seriously. Even when you get a number of reliable theories all saving the same thing—fundamentals, charts, economic analyses, political considerations—your investment is no sure thing. And if it does have heavy odds in its favor and if you make enough investments when the keys all agree, you will be successful. But whenever you begin to rely on a single key—don't. There is nothing inherent in the Dow Jones that makes it an infallible prophet of the economy. Since none of its individual components by themselves have any special knowledge, surely the sum total of the components cannot be relied upon for more intelligence.
Could it be that almost everyone has now been seduced by the tune of the Pied Piper—marching on a childish faith to an oblivion?
I believe that at one time the Dow Jones was a much better indicator than it is today. In the olden days when the tycoons practically ran the market, they knew ahead of time what they were going to do. They probably knew also what a lot of their friends were going to do. They were insiders. Their buying was a tip-off to what was going to happen. And their selling would have been a tip-off to what was going to happen. In other words, the leading wizards were also the leaders of the market. Things don't happen that way any more. The marketplace today is the sum total of every brain and also every numbskull who entered a transaction on that particular day.
*Most of the staunch Bears, one by one. have become Bulls. Even those who have not actually become rampant Bulls have, nevertheless, renounced the Bear for the foreseeable future. Of the letters I read, and they are many, only three others remain unqualified Bears—Tom Holt, Granville and Weiss. Former snarly Bears, but now rampant Bulls, are Dines, Russell, and Wellington.