It sounds like a bad day in pop psychology: Are you a spider, a cube or a diamond? Cognoscenti of exchange-traded investment trusts -- and aren't we all? -- will recognize these objects as the
Standard & Poor's Depositary Receipts
Nasdaq 100 Trust
Dow Jones Industrial Average Trust
, respectively. During the past year, the venerable DJIA became the
of the index world. Not only couldn't the
get respect, it didn't deserve any.
Traders must hold well-researched opinions with great conviction, but must be prepared to turn completely within seconds when the world changes. There is always another set of opinions, but real opportunities disappear quickly. The explosive rally in the Dow this past week constituted one of those moments when it is best to buy first and ask questions later.
While it is possible this was a sucker rally doomed to reversal, experience indicates a move like that with no apparent trigger signals the start of something big, very big. The low price-to-earnings ratio of Dow stocks and a weaker, post-rate-hike dollar mean that the charge of 30 giant stocks coming at you with a banner reading "Old Economy My A--" is far from over.
Sit Around and Surge
And while the Dow hit a rough patch today, it has surged on several occasions since 1982 after a prolonged period of consolidation and negative action.
Most of these surges came either in anticipation of or in reaction to a global upsurge in liquidity. The 1985-1986 market was a reaction to the
to drive down the dollar, while the 1987 surge was a reaction to the Japanese attempt to drive down the yen. The 1992 pop came after aggressive
loosening. At the same time, the 1995 rally began after the Fed stopped raising rates and the Japanese once again tried to drive down the yen. Subsequent rallies in 1997 and 1998 came after the Fed had to defer to the various and sundry global crises.
We are now nearing the end of another Fed cycle of tightening. Longer-term interest rates are now falling, and only partially in response to the
various bungled attempts at retiring government debt. No surprise here; I've been skeptical of incipient inflation for months despite various commodity price hiccups. The chart on 10-year note yields is poised to move sharply lower in weeks to come.
Tip From the 10-Year?
Another subtle, important and possibly dangerous factor in the long run is the continued absence of fear. The Nasdaq just completed its third 10% correction of the year during the middle of March. But with the price-to-earnings ratio of the composite and of the NDX standing at 528 and 154, respectively, on March 17, even the most wild-eyed techno/bio/connecto bulls should start to wonder why the recent correction happened.
Not so with the mundane Old Economy stocks; we noted
last week the P/E of the
was a cheap 7.25. The Dow transports began this week at a higher 7.58. The industrials' P/E is now 24.64. Now that the Nasdaq proved interest rates, earnings or even revenues don't matter, other indices are likely to follow. Previously unthinkable P/Es for household names may be just around the corner in what possibly may be a historic revenge of the value nerds.
Let's not mince words here. Our good friends at the Fed are not -- repeat, not -- going to torpedo a wonderful economy by raising rates too far. The stock market bubble is confined more to 20 super companies with dominant technical franchises (
) than to the rank and file. These stocks have demonstrated immunity to whatever has been tossed their way. Once the price of crude oil starts to break, and it will by summer's end, the latest Chicken Little inflation scare will be over.
The key behind the coming Dow rally will be a weakening of the dollar on foreign exchange markets as the interest rate hikes end. The Dow has a huge foreign earnings component, and a weaker dollar will help
, among others. Since 1986, the relative performance of the Dow against the S&P has been inverse to the dollar's strength.
How high is high? A breakout over the January high of 11,700 measures to 14,600, and that figure could be reachable by year-end. A quick perusal of the Dow's 30 components yields only a few uninspiring charts, principally
and the recently eviscerated
Procter & Gamble
. Philip Morris, priced more as a defendant than as an operating company, is wildly cheap; its
Kraft General Foods
unit is likely worth more than the parent company alone.
And, as for P&G, people will still use toothpaste and laundry detergent, although perhaps not as often as they should.
From this point of view, the key move could be to buy the Dow unit trusts because if nothing else, Diamonds are more attractive than SPDRs.
Howard L. Simons is a professor of finance at the Illinois Institute of Technology, a trading consultant and the author of The Dynamic Option Selection System (John Wiley & Sons, 1999). Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he invites your feedback at