Time For A Pause?

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As this is being written, the Dow Jones Industrial Average (DJIA) is flirting with 13,000.  It crossed it earlier today and is trading just below that mark, a level we haven't seen since 2008.  That's the good news.  And maybe there isn't any bad news, but it helps to look at what's happened over the just the last 6 months as the market has moved up rather dramatically.

Here's the data: the DJIA was as low as 10,362.30, touched in October of 2011, less than 6 months ago.  If the Average closes above 13,000 today, that's an improvement of 25.49%.  If you take the low point in November of 11,300, the gain is 15% in about 3 months.  Compare that to any other returns you might have made in other asset classes.  Or to a CD rate.

Looking at the charts a little more, from the low of 10,362, the DJIA rallied to 12,200 within about a month, for a gain of 17.74%.  But then it dropped to 11,250, a loss of 7.8% in one month.  In other words, these are the numbers that back up your experience.  The DJIA is volatile.

Now it's moved up rather quickly again.  If you annualize the returns made in the last 3 months, that's over 60%.  Markets don't usually let investors have this kind of return for long.  They have a way of taking back what they've given, especially over the last 10 years.

I certainly don't know if the DJIA is going to 15,000 or 10,000, but I do know that history shows a very volatile index.  Most of the time when it goes up rather fast, it also goes down very fast, usually even faster than in the time it went up.

What could cause a rapid decline?  Simple profit taking could be one reason.  Institutional investors, especially hedge funds that trade the market, don't buy and hold.  They're in and out of the market all the time, making huge bets on individual stocks by buying or selling short, then doing the opposite to close out with a profit.  Or they use options.  Or they buy or sell indices.  They move markets.  If they think the current run is over, they'll bail out and hit whatever bids are available.  The reason for getting out?  Just that they think prices sufficiently reflect stock values given the current market level or they've enjoyed a quick run up in their stock holdings and know that taking profits is much more enjoyable than riding losses down.

Another possible reason?  There are hundreds of them.  One prominent problem is Greece (current bailout funds will only last 3 months).  There's no way Greece will solve enough problems in 3 months to stablize the economy.  It will be back for more help.  Other European nations such as Portugal, Ireland, Italy and Spain also are teetering on economic cliffs.  Some may need outside help.  Where will it come from and at what cost?

Domestically, our financial situation has improved a little but has it been enough to justify this kind of market improvement?  Yes, employment is a little better, but the housing market is still collapsed.  Autos are selling well.  Interest rates are staying low.  Those are positives.  But the real support for any economic recovery is jobs.  We don't have enough of those yet.

It's always helpful to look back and see where we've come from.  And how fast we got here.  If we had gained the recent heights over the last year instead of the last 3 and 6 months, it might be a little easier to believe we'll be staying at this level or moving higher.  But given the rapid rise in the DJIA, it may be time to take a few profits and see what happens next.

(To see what the DJIA has done since 1929, see: http://finance.yahoo.com/q/bc?s=^DJI+Basic+Chart&t=my
It gives a good perspective on why buy and hold investing strategies will work over time.  The challenge is to be able to buy and hold for a long, long time in a stock that makes it through whatever economic difficulties the U.S. economy endures.)

- Ted Allrich
February 21, 2012



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks

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