The BMW Method
A Rational Dow 30?

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By BuildMWell
July 22, 2008

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Ahhh, there is a break in the home building action and I have some time this Sunday AM to do some catching up here. I hope I am not too late to add my input to this great discussion.

TwinDeltaTandem started a recent discussion about the "Lows" that we might potentially see in the DOW 30. It is always good to look for the worst case. He clarified later when he said, "I'm not sure how many times I said in yesterday's posts that I wasn't arguing we'd actually see 4,000...but I'll repeat it. I'm not saying we'll actually see 4,000."

Denny Schlessenger responded:

"I read your post multiple times to be sure I understood what you were saying. I think it was a well written and a well thought out post. You explained the methodology you used to arrive at the 4000 number and you adorned this with all the proper and necessary hedges and caveats. I don't have a problem with the number 4000 per se as presented in your post and my post was not meant as a criticism of your post at all.

Let's face it, the method you used is standard practice, marking a channel on a chart by joining what seem to be relevant and related price points. The critique that I never posted was your choice of a 67 year chart (1941-2008). I would have used a shorter chart for reasons I have discussed before, the acceleration of the economy with technological advances. By using a shorter chart I would have arrived at a higher low point but it would have neither more nor less credibility than your 4000 number for all the reasons you stated in your original post."

This is where I would have loved to have entered the discussion to add my position by applying the BMW Method to the data as I see it.

I strongly agree with Denny that the 67 year chart or a 100 year chart will give us the wrong picture if we try to apply the BMW Method to it. The question is, "Why?"

The key inflection point is 1958 and I always point this out in my presentations at the annual BMWM conference. That was the year when things changed and turned investing dynamics upside down to some extent. Here is the chart I used at the 2005 conference that shows the investor's change in perspective.

We can quickly note how the historical 10-year treasury yield moved above the dividend yield for stocks. Before 1958, stocks were expected to pay dividends in excess of bonds, but after that time, bond yields took off and stocks suffered for many years to come. Why would an investor buy stocks when the treasury would "guarantee" 6%, 9% and ultimately 15% on your money? Why we do not hear more about this sea change and how the market reacted is beyond me. However, if we apply the BMW Method to the data we can see what resulted from the idea that was sold to investors in 1958. The "new" idea circa 1958 was growth over dividends and after some growing pains, we see that it actually worked...and is still at work today.

From the early 1800's until WW-II, stocks paid dividends averaging 4% to 6% while the compounded annual growth of the stock market was around 2% to 4%. Edgar Lawrence Smith's book "Common Stocks as Long-Term Investments" quatified this for us in 1924 when it was first published. If we extrapolate his data out to the present day, it shows a DOW 30 of around 2000!

However, once our industry began to emphasize growth of the business by reinvesting the dividends and the public accepted the idea, the market grew at 8% to 10% while paying a 2% to 3% average dividend. The total return was improving!!! However, the internet bubble proved that there is a limit to that growth.

If we extrapolate the shorter term data to today, the "low" DOW 30 is around where it is today. Thus, I am a firm believer that we are not going to see a DOW much lower than what we saw last week. With the 10-year treasury at today's levels many, many stocks are paying higher dividends than the 10-year treasury. We have almost returned to pre-1958 condtions, but the growth is still close to 8%. So, why would a rational investor put his money into treasury notes when he can buy blue chip equities and get more bang for his buck?

Again, let's look at my 2005 BMW chart for that data.

We have come full circle back to rational treasury yields. That is a really good thing and it is never discussed in the media. They concentrate on the short-term negatives that have little to do with the big picture. Look at reality.

American Companies are still producing fine earnings and the weak dollar is helping export sales. Low interest rates encourage expansion and growth. We are really in a wonderful situation that is economically excellent! Why all of the doom and gloom? Please stop listening to the gloomsters and think for yourself. This is America, and America knows how to make money. This country is rolling right along and even high gasoline prices have not brought us down. We have slowed down quite a bit, but that doesn't in any way mean the DOW needs to go to 4000 or even to 10,000. The DOW could easily be at 15,000 and be undervalued.

Oil is in a bubble and it has taken other commodities up with it. Heck, Try applying the BMW Method to oil prices since 1960 and see what looks rational to you. Today, $35/barrel seems more rational to me than $135/barrel. Speculators manipulate prices and stories can be sold to the public to entice suckers to pay too much, but rational thinking folks can see that things will revert to the mean and prices should be reasonable based on history. At least, that is what the BMW Method has taught me. Please feel free to apply the BMW Method for yourself and make your own decisions. I am not here to sell you anything...except the BMW Method. And, I think that it sells itself.