Newsletter

October 7, 2006

A System Everyone Can Use

Market & Sector Review
Dissecting The DOW

Largest Changes In Raw Numbers (21 Days)

This Week's Economic Reports

A System Everyone Can Use

"Your brain is much better than you think, just use it!"
- Leonardo Da Vinci

Whether you think you can, or think you can't, you're absolutely right. The novel and the movie "The Da Vinci code" has brought this fascinating individual to the forefront in recent years. I believe that we can learn a great deal from Leonardo Da Vinci as well as others who have gone before us.

Just like the young learn to survive by following and imitating their parents, a key component to being successful is to imitate successful people. Humans, unlike any other species, can choose whom they would like to imitate. Leonardo Da Vinci felt that throughout our lives, and all of its stages, we should learn to consciously choose role models and to replace the ones we outgrow.

By doing this you will begin a positive adventure toward your worthy goal. For example, if you want to become a better trader, study the great traders, Jesse Livermore, Paul Tudor Jones, and Victor Sperandeo, to name a few. Read what they have written and what is written about them. Study their habits and imitate them. If you want to become a leader, study Abraham Lincoln (he never quit) or Winston Churchill.

Michael Gelb who wrote the book "How To Think Like Leonardo Da Vinci" writes, "It would take an encyclopedia to begin to do justice to the full scope of Leonardo's accomplishments." Da Vinci had visions. What set him apart is that he acted on his ideas. What's most fascinating is the fact that Da Vinci had a "system" he invented and followed religiously every time he began a new idea. It's a very simple system you can use to help you achieve your goals.
Da Vinci called it the "Smart System", S M A R T, being an acronym for:

S - Specific: Define exactly what you want.
M - Measurable: figure out how you're going to measure your goals.
A - Accountability: Commit to being personally responsible for achieving your goals. If part of a team, be sure that accountability is clear.
R - Realistic/Relevant: Set goals that are ambitious but achievable. Make certain your goals are relevant to your purpose.
T - Timeline: Set a clear time line for the achievement of your goals.
Great plan, wonderful system, easy word, "SMART".

By the way, I'm sure you know that Da Vinci created the timeless paintings, "Mona Lisa" and "The Last Supper". But did you know that he also created the parachute, bicycle, helicopter, folding chair, alarm clock, and the first comprehensive drawings of the human anatomy! Not a bad role model himself!
Market & Sector Review
Dissecting The DOW

During Tuesday's session, while listening to CNBC (official stock market cheerleaders) I couldn't help but hear that the Dow Jones Industrial Average surpassed the all time high made in 2000. "The 110-year-old Dow rose to 11,755.51, topping the intraday record of 11,750.28 set on January 14, 2000" (Briefing.com). Then after the close I read: "Dow Surges Past Its All-Time Trading High Finishes at Record-High Close of 11,727" (AP Newswire). Quite frankly I thought to myself, gee isn't this wonderful, but what does it really mean? Does it mean the bear market thesis put forth by many, myself included, is now dead, and we are off to new lofty heights? Remember the book published in the late nineties: DOW 40,000 or was it 100,000? The one thing I certainly hope it means; you are making money in the market. For fun let's break down the DOW into the component issues and see what is going on.

I ran a small program which looked back in time at all thirty (30) component stocks to determine their respective 7 year highs, their close today (Tuesday October 3), the respective sector they represent, and of course the percent change from that 7-year high. Here is a very interesting spreadsheet showing exactly what I uncovered. Remember when viewing this is as of the close on Tuesday October 3, 2006 - just in case things have changed since then.

The DOW closes at a new record high and not one single component issue is at new record highs; although American Express and Proctor & Gamble made new highs recently, and Altria Group and Exxon Mobil made all time highs a little over a month ago. Still that is only four of thirty issues or about 13%. As an interesting aside the average time since new highs were attained by the DOW components is 55.3 months. How can this be possible? Actually quite easily, let's explore the why.

The individual components of the DOW are occasionally changed as "market conditions warrant". They are selected by the editors of The Wall Street Journal. When companies are replaced, the individual weightings are adjusted so that the value of the average is not directly affected by the change, at the time of the change.

On November 1, 1999, Chevron, Goodyear Tire and Rubber Company, Sears Roebuck, and Union Carbide were removed from the DOW and replaced by Intel, Microsoft, Home Depot, and SBC Communications. Intel and Microsoft became the first two companies traded on the NASDAQ exchange to be listed in the DOW. On April 8, 2004, another change occurred as International Paper, AT&T, and Eastman Kodak were replaced with Pfizer, Verizon, and AIG. On December 1, 2005 AT&T's original T symbol returned to the DOW as a result of the SBC Communications and AT&T merger.

Would the DOW be at new highs if there were not any changes? Quite frankly I do not know, nor do I have the resources to go back and check. But let's take a look at the DOW components in another way. Let's take their respective closes at the bear market low on October 9, 2002 and look again at their respective closes on April 8, 2004 the date of the last change.

Since the last component change, the DOW is up approximately 14% however 12 of the 30 components (40%) are actually down over that time frame. Four (13.3%) of the 30 components have declined below their respective bear market lows. In each time frame only about half of the components outperformed the average, some however performing at four or five times the averages advance, and some of the heavier weights as well.

While most market indexes are market-capitalization weighted, the DOW (and other Dow Jones indexes) are price-weighted. That is, the DOW was originally calculated by simply adding up the price of Dow components and dividing by the number of stocks in the index. (That's why it's called an average.) However, when companies had stock splits or gave out stock dividends, the stock prices changed even though the value of the company didn't. The index, because it is price-weighted, would be distorted. To solve this problem, Dow Jones introduced the Dow Divisor. It's modified downward to reflect corporate actions that don't fundamentally change the value of the company. Current Dow Jones Industrial Average Divisor is 0.14418073. That is to say; if every DOW stock advanced $0.25 the DOW would be up 52 points (0.25*30)/.14418073). This is precisely how you get a new high in this average with no new highs in the component issues and some components not even close to those highs.

Back to the question - what does the new DOW high mean? If you are trading DOW index futures and/or options from the long side it means you're doing quite well. If you are long those DOW stocks that are outperforming then you're also doing well. Other than that it has little meaning, except perhaps as an excuse for stock market cheerleader's to party or for the general public to feel better about their mutual fund investments. The question one must always ask is not what the DOW did, but what are the stocks I own or am short doing? That is all that really matters.

As talked about last week, Rotation, Rotation, Rotation, it's the DOW Jones Industrial turn!
Largest Changes In Raw Numbers (21 Days)

This Week's Economic Reports

Have A Great Week!

Bill

Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.