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March 26, 1999

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Subject: Re: Holy market caps, Batman!
Author: jkoisch

Vic in post x on the CMGI board: Before you get too worried, the Advance-Decline line has been in a long term down-trend for over three years. So this situation can exist for a LONG time before the market tops out. The top could arrive next week or this summer or later. Nobody knows when the top will happen.

Hypothetically, what would happen if Wall Street firms in the business of building indexes tried to build their indexes around successful companies? What if they took a very optimistic view of the phrase "representative of the general market?" Because, you see, to be really representative of the general market, you really SHOULD pick some real dogs and some real weak stocks and maybe a few companies filing for bankruptcy.

This is not what happens.

To continue. . .And what would happen if these Wall Street companies like The Wall Street Journal and Standard and Poor's succeeded? What if they really managed to pick the best and brightest out there, and instead of representing the general market they managed to pick the cream of the crop?

Which, by the way, is in these companies' best interest. Because, in fact, no one wants to create an index that would characteristically underperform the other indexes.

"In other words, if the indices keep pushing to new highs without good breadth, that means the winners keep winning and the losers can't get no love. It means that indeed the creators of the indices succeeded."

So to answer my own questions: What we have are the market indices rarely showing the dogs, and certainly not showing the dogs proportionately. The indices are full of winners. That they go up consistently shows a predeliction for winners rather than losers.

Take The NASDAQ 100 - they recently added CMGI!!!!? Huh? Everyone here knows how I feel about CMGI, but it is not representative of anything in the rest of the market. The only indication it gives (so far) is whether or not the internets are having a good day. It does not bespeak the economy the way GE did in 1904 in Charles Dow's first Dow Average. And if the A/D line is any indication, its recent strength is hardly representative of the general market. Yet there it is, in good company. They seemingly even bent a few rules to admit CMGI, since it has less float by far than any other company in the NAZ100.

The indices are a stock picking contest. That includes all of the politics, all of the posturing and maneuvering associated with any contest. Companies WANT their stocks listed on an index - it's a sign of legitimacy, it's a sign of respect, it's a sign of support from the people who make and influence opinion. And that's a good thing.

On the other hand we have breadth, which measures the general market. There's your indication of general market health, not the indices. But the indices were SUPPOSED to measure general market health, so we compare the action of the indices with breadth and feel like we have a picture of the market. Well folks, sometimes a cigar is a cigar. If the A/D line shows weakness, then weakness exists somewhere, but that may not invalidate the quality of YHOO's move today or CMGI's move tomorrow.

In other words, if the indices keep pushing to new highs without good breadth, that means the winners keep winning and the losers can't get no love. It means that indeed the creators of the indices succeeded. It means that the market is a tough place when you're a so-so or worse stock with no sponsorship, index or otherwise.

I contend that the "real" universe of stocks has actually shrunk, as guaged by the indices picking all the winners (look at the KP list of possibilities and compare it with the possible 8,200 stocks out there). You could prove this by comparing trading volume of stocks in the various popular indices with stocks not in the indices. My guess is that the volume and the dollar volume will lean heavily in favor of the "popular" stocks.

Further evidence for my hypothesis is the down trending Russel 2000 these last 3-4 years. All of the same arguments apply, but we can be a little more specific. Why take on the risk of small cap stocks when you have the "safety" of global company blue chips offering better returns.

It is a good and legitimate question to ask, Which comes first? The stock being really good or the index choosing it to be really good? Sometimes the answer will be very clear, as with CMGI. Other times, it will be very muddled. It really doesn't matter in the final analysis - the leaders will lead, at least for now. With good information and/or a good message board, we can quickly identify the leaders.

"What I'm saying here is not a condemnation of the way the system works. On the contrary, it works brilliantly, if inefficiently. The system as it exists is a magnet for money from around the world."

Vic noted that the A/D line is in a 3 year down trend. I don't find that surprising at all. I heuristically think that this leg of the bull market has a different flavor than any other leg since 1982. EG, a 3 year down trend of the A/D line suspiciously coincides with the barriers to dissemination of market information being torn down via the internet. With perfect information, who will willingly pick a dog stock? With 1000 hypsters, hucksters, and news feeds hyping the latest winner, where is the money going to go?

Intrinsically, there is one factor to the 1982 Bull Market that has not graced any other bull market - the winners have in part been picked for you. Buy the S&P 500 Index and you're buying some great companies with very little digging. Look at the NASDAQ 100 - it paints a pretty picture. Look at the stocks represented in the A/D's. You have ~3500 stocks on the NYSE, you have 4745 on the NASDAQ. That's a lot of wheat to separate from the chaff. And believe me, there's a whole lot of chaff.

What I'm saying here is not a condemnation of the way the system works. On the contrary, it works brilliantly, if inefficiently. The system as it exists is a magnet for money from around the world. It's a rigged bet, where the winners come from a pool. It's a horse race with 8,250 horses, and I'll give you a list of 500 (S&P) or 100 (NASDAQ) or 30 (Dow) to watch. A lot of folks have made a lot of money betting on IBM, MSFT, GE, and GM to win, place, or show.

In the end, it is both a market of stocks and a stock market. The same information affects each entity differently. What's important is to understand that the map is not the territory. Don't confuse the symbols that are painting a picture of reality with reality. The question is whether or not the symbol affects your basket of stocks, your stock basket, both, or neither.