Has the Dow Left You Dazed and Confused?

alrightYou don't rebalance your portfolio on a regular basis? Be a lot cooler if you did.

Let’s set aside the fact that the Dow Jones Industrial Average is a flawed measure of the overall stock market.  The media, your parents, and their parents have all accepted the Dow as the standard.  Besides, over time the Dow does move in line with the overall market.  So instead of arguing semantics, let’s talk about the headline: a 4-digit drop in the Dow today along with a 600+ point drop on Friday.

While the average person associates the Dow with the overall market, we should also recognize that the media loves the Dow because of the potential for attention grabbing headlines.  To paraphrase Wooderson in Dazed and Confused: That’s what I like about the Dow, the points get bigger, but the size of the returns stays the same.

On average, the S&P 500 experiences a drawdown of 14% every year.  If we apply that average to the Dow, it would still need to drop another 1,455 points to hit that average for 2018.  That seems like a long way, but it’s really only 6%.  Since the market was up so much in January, that would put the year to date return at about -8%.

Quick Dow history:

  • The Dow peaked at 14,164.53 right before the great financial crisis (10/9/2007).
  • The Dow dropped 7,600 points, closing on 3/9/2009 at 6,547.05, a drop of 54%.
  • From here, the Dow gained almost 20,000 points (with some hiccups along the way) to 26,616.71 on 1/26/2018.

What if we had a crash similar to the great financial crisis?  In point terms (7,600), it would be a 28% loss.  In percent terms (54%) it would require a 14,373 point drop.  Same wording, but very different outcomes.  There is a tendency to anchor Dow points to a specific time.  It can be difficult to wrap your head around how different 1000 Dow points meant in 2009 (15.3%) versus 1000 Dow points today (4.1%).  This is why you’ll often see down days reported in points and up days as percentages.  Humans seek out information on potential pain and put more trust in those sounding the alarm the loudest.

Already on CNBC and social media, theories are flying about why the markets have been down so much in the last two days.  A short list:

  • A Bank of America Merrill Lynch memo to clients said their indicators had finally changed to sell
  • Investors suddenly got freaked out by inflation
  • With the 10-year Treasury nearing a 3% yield, investors are moving out of stocks to chase yield
  • Sellers of volatility are being targeted (by whom?) – they’ve enjoyed a free lunch for too long
  • They (again, not sure who ‘they’ is supposed to be) are shaking out the weak hands in the market
  • Bitcoin
  • Algorithmic/computer traders
  • New Fed Chair appointed
  • Super Blue Blood Moon (ok, I’m pretty sure nobody is saying this)

Bitcoin is a newly evergreen scapegoat for everything since nobody can explain the damn thing anyway – maybe this is code for blaming millenials?  Algos are another go-to for similar ‘nobody knows how this works’ reasons.  Honestly, this is all just chatter.  No one knows why the market has been down for the last couple of days or what that means going forward.  The point of this blog post is to shed light on the scary points number and contrast that with the percent returns.  None of this matters for a long term investor other than providing an opportunity for tax loss harvesting or rebalancing.  The how, why, what-if just doesn’t matter.  Don’t trust anyone who claims to have the answer for why the market moves on a day to day basis.  Don’t trust anyone who puts emphasis on Dow points rather than percentages.