The Dow is a limbo stick these days.
In an extreme case of one-upmanship -- or, technically, one-downmanship -- the financial media is scrambling to peg the most abysmal round milestone on the Dow Jones Industrial Average.
How low can you go?
- "What's Next? Dow 5,000," wondered our own Morgan Housel on Monday.
- "Dow 4,000 or Lower," pondered CAPS blogger abitarePERFECT on Tuesday.
- "Dow 1,000" was a punchline on Comedy Central last night.
Market swoons used to feel dizzying. Now we seem numbed by it all, with downward-pointing red arrows serving as some form of fiscal Novocaine.
I've never mastered the art of limbo. I lack the grace, dexterity, and nimbleness to clear the bar, I guess. So let me cut against the grain today, and suggest that the Dow won't hit 5,000.
I won't leave it at wishful thinking. I'll show you my math.
1. The Dow is flawed
The Dow has done a pretty decent job of mirroring the broader S&P 500 moves, but its shortcomings as a price-weighted gauge are about to be exposed. See, the biggest problem with the index is that it isn't based on market cap or enterprise value. Every point that a stock sheds -- or gains -- results in a 7.96-point move in the Dow.
This may not seem like a big deal to you, but let's put it in its proper perspective. General Motors (NYSE: GM ) is one of the 30 stocks that make up the index. It closed at $2.20 yesterday. Let's go with a doomsday scenario. The government snaps to, realizes that it's throwing good money after bad, and decides to let GM file for bankruptcy. Shareholders get wiped out. The impact on the Dow would be just 17.5 points, or less than a 0.3% dent.
Let's get grim on Bank of America (NYSE: BAC ) and Citigroup (NYSE: C ) , closing yesterday at $3.59 and $1.13 respectively. What would happen to the Dow if the government nationalized the two hobbled banking giants, rubbing out common shareholders along the way? The end result would be just a little more than a 0.5% smack.
In other words, if 10% of the Dow's most troubled components went to zero, the actual index would take a mere 0.8% hit. Even the punching bag that General Electric (NYSE: GE ) has become -- the company that only a few years ago commanded the world's largest market cap -- would deal the Dow less than a 1% blow if it went Nil City.
Naturally, one can argue that the market as a whole wouldn't be immune to the catastrophic failure of icons like GM, Bank of America, and Citi. However, doesn't there come a point where the market rallies around the market-share-gobbling survivors?
2. The higher-priced components are sound
At a price of $89.49, IBM (NYSE: IBM ) commands the largest share price of the 30-stock index. Under the ludicrous scenarios of IBM going to zero -- or doubling -- we'd be talking about a better than 10% move on the Dow.
It's true that IBM is a fair proxy for Corporate America. The company is likely to feel the pinch if layoffs continue and corporations scale back on IT spending. IBM is holding up well, though. Earnings per share climbed 17% in its latest quarter.
If you're holding out for a belly flop, Wall Street sees the company's earnings expanding this year. Oh, and before you dismiss analysts tracking IBM as Kool-Aid sippers, keep in mind that they have underestimated IBM's earnings for seven consecutive quarters.
Some other high-priced Dow components worth considering are McDonald's (NYSE: MCD ) and Wal-Mart (NYSE: WMT ) . Just in case you've missed the memo on the stellar comps at these two consumer-facing companies lately, these two are built for recessions. They account for a healthy 12% slice of the Dow.
The high-priced Dow components are holding up well. The low-priced troublemakers couldn't move the needle if they tried.
3. Walk like a contrarian
Turning off my calculator long enough to step up on a soapbox, what's the first thing that runs through your mind when you see all of the grim headlines of lower milestones for the Dow?
Don't answer right away. When we're in the euphoric phases of a bull market -- and CNBC commentators are talking about loftier benchmarks like 10,000 or 15,000 -- don't you find yourself shaking your head?
Two weeks ago, when gold futures hit $1,000 -- or this summer when oil topped $150 -- did you catch the folks calling for gold to hit $2,000 an ounce or oil barrels to top $200? Bullish optimism feels so silly in retrospect. Shouldn't the same rules apply to bearish pessimism?
You can't spell "down" without D-O-W, or "super" without S&P
I'm not cocky enough to call this a bottom. We all know that the economy has some serious problems. However, my inner contrarian -- and my ability to learn from history -- means I know better than to follow the herd. Besides, hasn't much of the meltdown already been factored into today's stock prices?
I don't know when the sentiment will turn. Maybe it will be next month, when consumers find a little more take-home pay in their paychecks. Maybe it will be when the past few months of layoffs begin to pay off with surprisingly heartier profit margins when earnings season kicks in come mid-April.
Until the "Dow 5,000" headlines become "Dow 10,000" teasers, I see little reason to crank up the Harry Belafonte and give the limbo stick a crack.
Some other ways to get down with the Dow:
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