Dear Friend and Reader,
I WAS LUCKY enough to catch a few minutes with my friend John Curran who works in the financial sector (his primary experience is in hedge funds) and is still secure in his job in Manhattan. In between his train ride home (he’s just like Joe Biden!) and some time with his family, I asked him some questions about the Dow Jones and the recent market changes.
While researching for an earlier article, I realized that for all we’ve been reading and writing about the Dow, I wasn’t sure exactly what it was, where it comes from and what the difference is between, say, the Dow Jones Industrial, Transportation, Utility and Composite Averages.
First of all, the concept of trading is very old. In Prehistoric times, when humans first had the ability to speak, they traded goods and services for survival. During the Stone Age, the period when we started using stone tools, we introduced our first currencies: obsidian and flint. Obsidian flakes off to make very sharp points and blade edges, and flint is a fire starter. It’s the historical equivalent of trading Swiss Army knives and matches. (My mom is so proud I studied anthropology in college.)
As we evolved, and civilization became more advanced, our currency became less practical and more symbolic: turning to beads, silver and gold. By the 11th Century, “Muslim and Jewish merchants had already set up every form of trade association and had knowledge of many methods of credit and payment.”
To yank us up to present day, Wikipedia tells me the Dow Jones was launched in 1896 by Wall Street Journal editor and “Dow Jones & Company co-founder Charles Dow. Dow compiled the index to gauge the performance of the industrial sector of the American stock market. It is the second-oldest U.S. market index, after the Dow Jones Transportation Average, which Dow also created.”
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Charles “Beard-face” Dow.
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Now, I haven’t even checked yet, but I have two guesses for the natal Sun of Charles Dow: either Taurus (come on, what’s the symbol of the stock market?) or Gemini — quick thinker, multiple personalities with journalism, and creating this whole financial market indicator. Want to wager any guesses before I tell you? You can kind of tell from looking at the guy.
Nov. 6, 1851: he’s a Scorpio. I suppose that works too: cunning, cutthroat if necessary, highly intelligent, eminently psychic. Scorpio is also one of the most important signs of trade; of the exchange of goods and commodities in whether in a personal, business or market environment.
Plus, his Moon is in Aries, which explains his bold creative side: this perhaps influenced him to work in editing, which is more artistic than something heavily mathematical like the stock market. Mainly you can count on people with an Aries Moon to do something new, bold, original. Eric refers to this placement as the Dauntless Moon (scroll down that link for subscriber edition by this title from 2003).
Charles Dow originally just took the price of one share of each company’s stock, added the numbers up and divided by the number of companies. The average (literally, the arithmetic mean) when the index launched was 40.94 — a quaint little number compared to Monday’s close of 9,387.61, or the Dow’s record high of 14,165.43 on Oct. 9, 2007.
Today, Dow Jones & Co. (publishers of The Wall Street Journal) has come up with mathematical formulas to adjust for things like stock splits — when a company doubles the number of stocks its shareholders have, splitting the price of each in half — or new companies being added or removed. The idea is to keep the index consistent over time, and to make sure today’s value can be compared in a meaningful way to what it was a year ago or 10 years ago.
The Dow Jones index has four components that can be analyzed on a minute-by-minute basis. The Transportation Average looks at just that: the top 20 transportation companies in the country. These mostly consist of airlines, with a few scattered trucking and shipping companies. The Utility Transportation Average looks at the 15 top electric, diversified and oil and gas companies, while the Composite Average represents the market status of the top 65 companies, regardless of category. So it looks at utility and transportation companies too: it’s a big conglomeration.
John tells me the Dow Jones Industrial Average (DJIA), which we and anyone interested in stocks focus on, are “the biggest 30 companies in the Dow. These are 30 of the largest and most widely held institutions in the U.S.”These 30 companies are mostly household names, what used to be called “blue chip stocks:: Coca-Cola, Disney, Home Depot, McDonalds and Wal-Mart are all there. There are a few more: American Express, Citigroup and JPMorgan, that caught my eye. If the biggest financial institutions (that we have left) are influencing the DJIA, then it’s getting a bit clearer why the numbers are reflecting an insecure market. Every other day, we hear “the banks are closing,” “the fundamentals of our economy are very strong,” “call off the debates, we’re going down” and “Europe has a plan, we’re saved! Thank god the EU came around to tell Henry Paulson what to do…”
So why did the market do so well on Monday, but dropped a bit on Tuesday, down a further 733 points on Wednesday and then up 401 points Thursday with slow gains on Friday? I feel like I’m bungee jumping just writing about it.
John says the market bounced Monday because of the Columbus Day plans that were made public. Success “became obvious…continental Europeans and Gordon Brown came out to say they were partially nationalizing big banks by injecting capital into it and taking partial ownership in it. And people knew the US were going to follow suit. The partial-nationalization of banks were such a massive sell-off that people were looking for a reason to buy…It eliminated the chance of any more banks going bankrupt, [because major US, UK, French, Italian, German and Spanish banks are now partially owned by their countries].” The banks can only go bankrupt if the country goes down with it.
All of this confidence led to a massive jump in the DJIA. Without the threat of anymore banks going bust, people felt free to buy, buy, buy: and the Dow went up. Big time.
This reminds me of a scary time I had in college, not so long ago. I was a full-time student and I had a scholarship that gave me a small supplemental stipend to cover my rent. I never looked at my bank statements, I just figured if I ran out of money, I’d know.
One day, I went to an ATM to take out $40 for beer and supplies, and I couldn’t. There was no money left in my account. You can call me Iceland if you want.
(Too soon?)
I called my Mom, and she put $1000 into my account, hoping I would manage it and not make this mistake again. I threw a party, with lots of food and drink. A lot of fun was had that day, and spirits were high.
The next day, though, hungover and squinting in the harsh morning, I walked to class and it hit me: this cash flow problem wasn’t going to go anywhere, not as long as I was a student with a small stipend and a big spending habit. I was heading for a recession.
That’s basically what happened over Monday and Tuesday: Monday, our Mommies flooded the banks with cash, absorbing our credit like an older, responsible brother co-signing a loan. And we felt safe, again; secure.
Until the next day, when “fears about a forthcoming recession” returned. “The financial crisis is just the banks having all these problems because they have bad mortgages, and they’re not lending to each other which is causing the credit freeze.”
The problem is, and that’s what we’re realizing today, is “even if [the financial crisis is] all cleared up we’re heading for a huge recession.”
Of course, there are two factors that influence drive the market: emotions and practicality. A combination of fear and nerves, in addition to practical factors, such as Tuesday’s “sell-off because people feel they’ll be going bankrupt,” play into the points that the DJIA presents at the end of the business day.
Monday night, The Daily Show with Jon Stewart taught me that a record-breaking up day in the Dow is not necessarily a good thing: in fact, the highest single-day jumps occurred during the Great Depression and following the 1929 stock market crash.
The key word isn’t losses, it’s volatility. And measures of volatility in the market are bigger than they have ever been. The VIX, according to Wikipedia, “measures the cost of using options as insurance against declines in the S&P 500. Often referred to as the fear index, it represents one measure of the market’s expectation of volatility over the next 30 day period.”
Ups and downs are natural in the market. If it went consistently up all the time, then we wouldn’t need stock brokers to give us advice about how to make money in it, we’d just put our money in it, encourage our friends and neighbors to join in afterwards, and call it a pyramid scheme.
The real numbers we should have our eyes on are the VIX, also known as the Volatility Index. With record lows, record highs like Monday’s the alternating peaks and troughs from the rest of the week, we can see that the VIX is reporting one thing: instability. And that’s not the kind that’s influenced by daily fears, it’s the kind that means the recession is much like the melting of the polar ice caps: happening, and unavoidable.
So, essentially, there are two financial problems occurring: the credit crisis, which our government is dealing with via the “$700” billion bailout and flooding the market with greenbacks, and the recession, which is a natural downturn after at least a decade of upswing. I suppose it’s easier to let those middle American, Main Street, Joe six-packs believe we’re stopping the bleeding by using lots of money to soak up the hemorrhage, but eventually we’ll stabilize the credit and banking crisis.
When that happens, and the markets stay depressed, we’ll have to face the fact that it’s going to be one Wii per family this Christmas, and maybe worse.
Yours & truly,
