is on the move. An April 2 article in
TheWall Street Journal
noted that "the eurozone has stepped back from the brink of
collapse, the U.S.
is showing continued signs of life, and central banks have extended
efforts to support economic growth."
The piece, by Tom Lauricella, continues with the idea that the
stock market is no longer moving in lockstep with other asset
classes, which some take as a sign that it is about to break out.
"Cautious investors have scaled back holdings of high-quality
low-yielding government debt that had been a haven from last year's
turmoil" and are "willing to take greater risks."
Well, no surprise there -- the market has been rising this year
without a material change in the underlying fundamentals. In fact,
as the article notes,
this year are likely to be weaker than in 2011. This leaves
shifting investor sentiment about the market's future prospects as
the only reasonable explanation for the upswing. The point of the
article is that more and more risk-averse investors are beginning
to look for better returns than cash or fixed income can provide.
Their collective higher risk tolerance means they are willing to
crawl out from under their rocks and embrace equities.
As a great investment sage once said, "So what?"
Imean , to what degree can these investors continue to find the
same standout gains seen in the first quarter in the same places
investors usually look? In other words, what is the built-in high
for the blue chips these investors are buying?
front, of course, the sky is the limit, because stock prices can
theoretically rise forever. In the real world, though, stocks meet
resistance at a certain point and it's not too onerous to determine
where that is. In fact, it's just basic arithmetic.
The Dow Jones Industrial Average, as you know, is made up of 30
mega-cap stocks, the bluest of the blue chips. To determine the
value of the
, the individual share prices of each of the members of the Dow are
added together. The sum is then divided by the "Dow divisor," a
special mathematical tool that allows the editors of
TheWall Street Journal
-- who pick the index constituents -- to make substitutions in the
Average. They do this rarely, but without the divisor, they would
not be able to do it at all, unless the new stock had exactly the
same price as the old one.
The current divisor is 0.132129493. (And if you really want to
impress your friends, lay this fact on them: A $1.00 rise in the
total price of the 30 stocks results in a 7.6-point gain in the
So to determine the market's built-in high, I used the
for each stock instead of its current price. The built-in high is
almost exactly 14,000, or only about 7% above the Dow's current
reading. The members of the Dow have to make up all the ground they
have lost in the past year and then break new ground to push the
index above this point.
If you're a reader of my
newsletter, then you should remember Obermueller's Law:
The market is always trying to tell you something.
In this case, the message couldn't be clearer: No one seeking an
equity return in an otherwise up-trending market chases a 7% return
very hard. When the blue chips reach their highs -- and 18 of the
30 are already within 4% of that, with seven of them within 1.0% --
exhausts its appeal for aggressive growth investors.
It follows, then, that the next step is for more risk-tolerant
investors is to look to something other than blue chips, something
with a little more zing to deliver disproportionate returns -- "
" in market lingo.
This is exactly the sort of thing you need to consider, too.
As blue chips begin to break new ground -- which ultimately is a
matter of "when" and not "if" -- I think it will lead to a massive
shift in interest to small- and
stocks. As large caps crest, most investors -- captive to the
self-defeating idea to buy when everyone else is buying -- will
move sidelined cash into blue chips and reallocate
assets into indexed equities.
While these investors are coming in the front door, buying stocks,
another crowd will be leaving out the back door, selling. The savvy
investors who rode the blue chips from the market's bottom to the
summit will likely move on to greener pastures, following the adage
that (smart) money goes where it is treated best.
Action to Take -->
In this case, it's small- and mid-size stocks that will treat your
money the best in this market. And if you, like readers of
, allocate a small portion of your portfolio, say 20%, to small
companies that are working on "the next big thing," then you're
very likely to find yourself sitting on big returns -- even when
the overall market has hit its ceiling.
You can read more about the companies working on "the next big
thing" in my biweekly newsletter,
To find out more, click here to view this special
Andy Obermueller does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.