What If the Market Couldn’t Beat the Market?

By Lynn Carpenter

Dear Reader,

This week, the Dow Jones Industrial Average gets a makeover.  I find this amusing because of the “Efficient Market Hypothesis.”  That’s one bit of academic nonsense that not only affects you, it’s about you and me … and how dumb we’re supposed to be.  And it’s why playing with indexes seems so crazy.

In short, the idea behind the EMH is that you and I cannot ever beat the market in the long run.  Can’t do it.  We might as well go home, turn on American Idol, allow our broker to buy us some index funds, and quit worrying our pretty little heads.

The EMH portrays a stock market that would give our grandmothers’ quilting club a lesson in the speed of gossip.  Every bit of news about a stock is priced into the stock immediately, it claims.  That’s why – supposedly - none of us can discover anything fast enough to give us an advantage or any way to beat the market over time.

Oh yeah?  Well, then, there’s one little thing I’d like to know about this week’s Dow changes, then.  Why doesn’t the Dow committee let monkeys throw darts?  Why don’t they just draw symbols from a fish bowl?  Why are human beings allowed to select what goes into the Dow and the S&P 500?

You see, the profs base the EMH and their disdain for our abilities on a gazillion studies that they say prove the EMH by comparing the results of different stock-picking systems to “the market.”  And “the market” is – yep, you guessed it - one of those indexes put together by a bunch of humans.

So let me see if I get this correct.  Humans cannot choose stocks that beat the market when choosing stocks for their own portfolios.  However, humans who join committees can choose superior market-setting stocks when they are selecting candidates for market indexes.

Maybe all we have to do to beat the market is pretend we’re putting together a new index, huh?

This is only one of the many faults I find with the EMH.  And, I might add, it’s a major fault.  Because certain humans don’t do such a great job picking index stocks, either.  The Dow is a case in point, as we shall see again this week. 

The Dow committee has spoken.  On Tuesday, two current Dow stocks - Altria Group and Honeywell - come out of the Dow Jones Industrial Index.  In their place the Dow Jones board has decided to add Bank of America and Chevron.

This shakeup looks a bit strange.  The Dow already has four financial stocks - JP Morgan, Citigroup, AIG, and American Express.  It needs more?  That’s the official line.  But I say there’s already a fifth financial they’re forgetting to count.  It’s GE, because 19 percent of GE’s revenues are from its Commercial Finance and Money Divisions.  By market cap, that makes GE’s finance segment as big as American Express. 

In the energy department, the Dow already has ExxonMobil, the world’s largest oil company by market cap.  Chevron makes two.  But there is a beautiful symmetry here. 
Chevron used to be Standard Oil.  So did Exxon.  In 1972, Standard Oil of New Jersey renamed itself Exxon.  In 1984, Standard Oil of California became Chevron.  They may never join in a single company again, but they are reunited in the Dow.  John D. Rockefeller must be chuckling in his grave.

The rationale for the current shakeup is that the U.S. economy has more financials than the Dow did.  That explains Bank of America.  Altria is being dropped because it plans to restructure and will be a narrower company in the coming year.  So the Dow folks claim, anyway.

I’m not sure company breadth is a big thing at Dow.  If so, how in the world do they explain keeping  American Express, Coke, Cisco, or Merck?  They are hardly multi-line wonders.

And wait a minute … the U.S. economy has been top-heavy with financials for decades.  Why add Bank of America now?  In fact, why add it after financial stocks had their big run?  Maybe because it’s so cheap, the Dow board can be fairly sure it’s going to go up over the next five years or so?

As for departing Honeywell, it was a top stock last year, rising 36 percent.  You may think it’s an odd time to drop it, but the Dow has a history of cutting its winners.  You only have to look at IBM to see it.

IBM was part of the Dow long ago … until the board dumped it in 1939 to add AT&T.  Big Blue did much better than the Dow for the next two decades while it was out.  Maybe that proves that even those mysterious people who define “the market” can’t beat the market.

Finally, the Dow let IBM back in.  That was in 1979, just in time to catch its poor years.

Chevron was also kicked out of the Dow twice.  This makes its third appearance.  The first time around, it was called Standard Oil and had a really short run, from
February 1924 to August 1925.  The Dow let it back in 1930 after several of the hot young stocks it had put in the index had fizzled.

They kept Standard through its transition to Chevron in 1984, but in 1999 they booted it again.  The Dow folks wanted to add some tech stocks.  How’s that for insight, huh?  In came Intel, out went Chevron—which has remained out of the index through its whole 300% run from 2003 to this past year. Meanwhile, as its replacement member of the Dow, Intel has gone approximately nowhere since 2003.

One of the goofy reasons that the Dow makes bad decisions like this is that it is a price-weighted index.  When IBM was at $100 per share or more, it was too rich to add to the index.  It would have quickly become the most influential member.  But when it split four for one, Dow drew it in at last.  Intel also stayed outside when its share price was hitting high numbers.

The current changes don’t change one thing, though.  This still isn’t a very “industrial” index.  The industrials are only 22 percent of the current Dow Jones Industrial Index.

Sheesh, you can’t trust anybody.  Except yourself.  Go pick some stocks and let the professors fool themselves.

Respectfully,

Lynn Carpenter

P.S.  To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com.

INTERNAL ENDORSEMENT 

Winners Cherry Pick!
Losers Bottom Feed

Thousands of stocks have just fallen 40% or more... most will continue to tumble… but you should still overpower the markets.

Because a select few stocks are now set to roar back for outstanding near-term gains.

It’s time to party like it’s 2002
You don’t want to miss out… because, today, you can jump into any one of seven companies at what should be their once-in-a-lifetime lows… each is poised to take you to new highs.

Grab this low-hanging fruit here.

Singapore Sling

By Andy Carpenter

Dear Reader,

One of my favorite small U.S. companies got into a bit of trouble in Singapore this week, though I doubt the company cares one bit about it.

Blue Q, which makes products that some people consider novel, had one of its lines yanked off Singapore retail store shelves.  In particular, a leading Singapore retailer pulled Blue Q’s Jesus-themed cosmetics after it was pounded by complaints from local Roman Catholics.

That’s kind of shocking to me, considering the fact that I was raised around tons of Catholics.  Not only did they take their religion seriously but many, leading citizens and all, were fervent in their love for adult beverages and bawdy humor.

Maybe that’s just a Northeast thing.  Most Americans are not the priss pots that the media make us out to be.

It just that the prisses among us get a lot of media face time.  I mean, how many local TV news stories start off with this sentence, “ A local mother is up in arms because …”  Then you can just turn down the volume and fill in the blank with whatever teenage fad she’s against.

That makes the “news” seem more interesting than if TV reporters told the truth three or four nights a week.  As in, “Well, once again not much happened today in Dogpatch as locals went about their day under the oppressive influence of calm.  Back to you, Blondie.” 

On the other hand, Singaporeans are notoriously straight laced.  But they walk the walk, too.

You won’t find any U.S.-like religious scandals there.  In fact, the parishioners of most ultra-conservative evangelical churches would be very comfortable in Singapore … although, judging by the headlines, a number of their pastors would be doing two to 10 in a Singapore prison.

You’ve probably heard that selling gum in Singapore is illegal.  So is importing gum, though I think you’d be able to convince authorities that the kilo of gum in your luggage is for personal use.  It better not be Wrigley’s Doublemint, though.  That stuff sticks firmly to all it touches (outside the mouth).  Singapore authorities hate it.

And don’t get in the gum trade.  It’s two years for your first offense.

Also, don’t bungee jump in Singapore.

Don’t forget to flush the toilet.  Multiple offenses will yield a stiff fine.

And, Sen. Larry Craig, you better stay in Montana.  And Mark Foley in Florida.  Because your favorite pastimes would land your butts in jail in the city state.  Same goes for you, Ted Haggard and Paul Barnes.  Singapore hates homosexuals as much as you once said you did.

But it doesn’t stop there in Singapore.  Because all pornography is illegal, too.

So, I think the Rev. Gary Aldridge could have been in trouble in Singapore, since its pornography laws include what’s kept in the home.

Also banned are books such as the Marquis de Sade’s The Bedside Philosophers, John Cleland’s 18th century bestseller Fanny Hill and Henry Miller's Sexus.

Magazines like Penthouse and Playboy are banned in Singapore, too.  As is Cosmopolitan, I think.

In fact, the running joke in Asia is that Singapore is a “fine” city.

It’s illegal to use cigarettes in a public place in Singapore.  Plus, it’s illegal (or heavily taxed) to bring most tobacco products into the state.

Its strict laws against littering of any kind mean first-time offenders face a fine of up to $70.  Repeat offenders pay as much as $150 and are sentenced to a Corrective Work Order.  The CWO requires litterbugs to spend a few hours cleaning a public place such as picking up litter in a park.  The litterbugs are made to wear bright jackets, and sometimes, the local media are invited to cover the public spectacle.

In fact, Singapore would have been a great place for Jerry Falwell to have located Liberty University, if he hadn’t wanted it to also feature a D-1 basketball program.

So, the U.S., with its foundation built by those seeking religious tolerance, can tolerate some of Blue Q’s products merely by doing the right thing and not making a big deal out of them.

But Singaporean Catholics were being equally culturally consistent.

When they saw The Lookin’ Good for Jesus line on sale at three Topshop outlets in the Asian city state, they complained that the cosmetics’ marketing was disrespectful, full of sexual innuendo, and that it trivialized Christianity.

The products for sale in Singapore included a “Virtuous vanilla” lip balm and a “Get Tight with Christ” hand and body cream.  The latter features a picture of Christ flanked by two adoring women.

So, in Singapore you always know right where you stand … and that’s with Satan clearly behind thee.

See you sometime next week.

Andy Carpenter

P.S.  To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com.

If you enjoy IDE's daily investing advice, you'll definitely be interested in checking out our sister publication, Early to Rise. Each morning, you'll get powerful wealth-building advice covering real estate, entrepreneurship, personal finance, marketing, and much more.
Sign-Up for Early To Rise today!