Bull Market Genius?

Yes, amazing as it seems, we're in a bull market. The Dow looks to 10,000, the Nasdaq to 2,000. Whatever your definition -- a 20% rise in a major market average, high volume, the moon in the seventh house -- it's been stampeding bulls since last year's lows.

When stocks rise like this, investors often feel better. Our brokerage and retirement plan statements fatten. If we own stocks of riskier, aggressive growth companies, many of which boost the Nasdaq composite, we may see truly wonderful gains. Fortunate Netflix (Nasdaq: NFLX  ) shareholders (among them, subscribers to our Motley Fool Stock Advisor), for example, have watched the stock rocket 948% from its Oct. 9 lows.

Yes, with a little of the old bull, you might just feel... like... a... genius.

And why not be happy about good results? After three bear market years, it's nice to see some smiley faces. Here's a look at what the market averages have done since their 2002 low:

  Market                % Gain From 2002 Low*Average                 to 10/17/03 CloseDow Jones Ind. Avg        ** +36.1%S&P 500**                   +35.7%Nasdaq Composite Index      +71.6%
*Oct. 9, 2002 for all averages.
**Dividends included

Déjà vu all over again
But something nags at you. Despite the world's effort to keep us from holding any thought for more than 30 seconds (Change the channel! Answer that telemarketer! Read that spam!), memory tells you that this all seems very familiar.

There's a reason. After the Sept. 11, 2001 attacks, the markets reopened and began a rise very similar to what we've seen over the last year:

  Market               % Gain 9/21/01Average               to 2002 HighDow Jones Industrials*   +21.1%S&P 500*                 +29.8%Nasdaq Composite Index   +44.7%*Dividends Included

We felt pretty good then, too, or at least relieved. After the cliff-falls from 2000 bull market peaks, any respite felt sweet. But it was a momentary pleasure. The averages then fell precipitously from there to their Oct. 2002 nadirs (and I don't mean Ralph). A year ago, many felt that they weren't geniuses, but idiots.

Mr. Market's moods
But feeling like a genius or idiot is neither warranted nor helpful. The stock market doesn't move in some sort of lovely line guided by an average increase or decrease in corporate earnings. The moods of Mr. Market, so dubbed by founder of modern securities analysis Benjamin Graham, swing high and low. When all the Mr. Markets -- the mutual funds, insurance companies, hedge funds and investment banks that trade in huge volumes -- have the same mood and move in synch, markets sprint or crash. It's simple supply and demand. More big buyers than sellers, prices rise. More big sellers than buyers, prices fall. It moves just about any stock in its path, whether good, bad, gorgeous, ugly, diamond, or trash. It's emotion, not reason.

These dramatic moves can be worrying. Some fear they've missed something and believe they must act. They become prey to the time-honored way to lose money: to pile in at times of maximum enthusiasm and pile out at times of maximum pessimism. Others see their own stocks rise and become overconfident, forgetting the basics of research and valuation.

Herein, a prescription for all. Avoid the moods, and stick to your knitting.

What, me worry?
There is no need to act. Let's say you've ventured beyond a broad-market, low-expense stock index fund to choose a few large cap stocks well-known to you in your daily life, such as Home Depot (NYSE: HD  ) , McDonald's (NYSE: MCD  ) -- now there's a turnaround -- or Citigroup (NYSE: C  ) . Not a bad idea, given Graham's view that when investors choose individual stocks, the popular stocks do the least harm. Generally, and with individual exceptions, the longer you hold a basket of them, the less serious the fallout if you purchased at a high valuation.

Not that these stocks always gain. Far from it. But while you may or may not do better than a broad-market average, you won't cause as much damage as if you attempted the minefield of smaller companies whose businesses may be far from your daily life -- the battlefield Graham reserved for the analyst.

Thus safer (there is no "safe" in common stocks) from harm, you can then emulate Alfred E. Neuman, hero of Mad Magazine, and follow his dictum: "What? Me Worry?"

Not the Dogs of the Dow
Then, there are investors who during 1999-2000 bought a slew of less familiar stocks, many of which comprised the Nasdaq composite, but who were unprepared for the risks. We know what happened. Even with gains from 52-week lows, the major market averages still stand below their 1999-2000 bull market highs:

  Market                 % From Year    DateAverage                 Bull Top     of TopDow Jones Industrials*   - 8.7%     4/11/00S&P 500*                 -29.1%     3/24/00Nasdaq Composite Index   -62.1%     3/10/00*Dividends Included

Despite its 71.6% gain from a year ago, the Nasdaq is 62% shy of its March 2000 highs. The S&P 500 somewhat better, and -- were you prepared for this? -- the Dow Jones Industrial Average (dividends included), the best of all, down a mere 8.7%. Holy moly! What investor who bought JDS Uniphase (Nasdaq: JDSU  ) at its height or the hapless Global Crossing or Globalstar wouldn't be happy with minus 8.7% from April 2000?

Boring old Dow stocks look pretty good.

What gives?
This result is surprising. After all, the market caps of two alone, Microsoft (Nasdaq: MSFT  ) and Intel (Nasdaq: INTC  ) -- number one and six on the Dow -- dominate all three averages. You would think that their 51% and 55% drops from 2000 highs -- the latter even with Intel's phenomenal rise this year -- would bring down the Dow Jones Industrials down more.

Ah, therein lieth the rub. The Dow Jones Industrial Average Index is price weighted, not market cap weighted like the S&P 500 and Nasdaq. So the stock with the largest market capitalization in the known universe (unless Star Wars had a stock exchange) -- Microsoft at $313 billion -- doesn't move the average anymore than a stock of similar price. Wow. Didn't anyone ever tell these people that it's market cap not stock price that matters?

Apparently not, and it's certainly a good thing for anyone who has bought the Dow Jones exchange-traded fund, Diamonds Trust (AMEX: DIA  ) . The Dow is a sleepier index that provides a large part of its returns through dividends. Seven of the 30 yield over 3%:

  Company                  Dividend YieldAltria Group   (NYSE: MO  )         6.05%SBC Communications   (NYSE: SBC  )  5.14%AT&T   (NYSE: T  )                  4.68%General Motors   (NYSE: GM  )       4.56%JPMorganChase   (NYSE: JPM  )       3.69%DuPont   (NYSE: DD  )               3.45%Merck   (NYSE: MRK  )               3.01%

With Microsoft a holdout no longer, all of the Dow 30 offer a dividend. (Caveat: Not all dividends are created equal, which is why you may wish to try Mathew Emmert's Motley Fool Income Investor). So boring and dividends look pretty good.

Stay the course
With the year of good returns from the market averages, investors may be swayed by emotion positively or negatively. But we are neither geniuses in bull markets nor idiots in bear markets. The path doesn't change. We evaluate businesses. If we are not interested in learning about valuation, we can buy broad-market, low-expense index funds and -- if the Dow Jones Industrials' returns are our guide -- perhaps a few large well-known companies offering dividends plus growth to hold for a long time.

With more confidence in financial statement analysis and help from trusted sources, we can thread our way through fundamentals to find growth at a reasonable price, a.k.a. value stocks, buying at discounts to intrinsic value. Some of us may choose to take on the significant risk of a few well-chosen speculations. Whatever our strategy, we always use a discount broker.

Let our motto be, "Bull or bear, we don't care."

Penny companies
Thanks for all the mail last week responding to my column about penny stocks and penny companies, which are most often domains of hype, manipulation, and worse. In bull markets, cheap stocks are usually cheap for a reason, but bear markets may decimate stocks of decent or better companies, creating exceptions to the penny-company rule. Beware, but if you are confident in your financial analysis skills, you may rarely find some deep value. Just keep this front and center: Many will be called, but very, very few ever chosen.

Condolences
Cubs fans probably feel like this: I was in line at the supermarket the night after the Marlins' victory in the National League Championship Series and asked the cashier if he was going to watch the Red Sox-Yankees game. Before he could answer, a woman in the next line -- clearly a Cubs fan -- overheard me, turned and sighed, "There's just no reason to watch baseball anymore."

To her and others, deepest sympathies. And best wishes to the Yankees and Marlins.

Have a most Foolish week, and thanks for reading. Find your favorite Fool writer's stories via the "Browse Stories By Author" drop-down menu on our Fool.com home page. If you would like an email whenever I write a column, send me a note at TomJ@Fool.com with "mailing list" in the subject line.

Senior Analyst Tom Jacobs throws a mean screwball. Or he is one. Whatever. Tom is guest analyst in this month'sMotley Fool Hidden Gemsand owns shares of Microsoft. To see his stock holdings, view hisprofile, and check out The Motley Fool's great-tasting disclosure policy.


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