The Blunt Truth About Dow 20,000

General excitement about Dow 20,000 seems more prevalent these days than legalized marijuana. Which is to say it’s everywhere, man. And which is to say if you’re not careful, the whole Dow 20k thing can leave you at least as dazed and confused as any bunch of grass from the local dispensary.

That’s because, despite all the smoke, excitement about how high the Dow is has some practical merit. Rolling bunches of relevance and irrelevance together more tightly than Cheech Marin could spin a J, the Dow 20k haze is a pure and unadulterated case study of exactly what happens in the stock market all the time. It’s like truth, man. But it’s a blunt truth.

Why is that? Because Dow 20,000 means exactly nothing and precisely something all at once. Whether you believe Dow 20k is a relevant factor for stocks or not, it doesn’t change the fact that lots of people do seem to believe it’s a relevant factor for stocks. And that means you might want to believe it, too.

If all that sounds kinda trippy, it’s because it is. Man.

But what’s even farther out is what we should do about it.

The Blunt Truth About Dow 20,000

Be Trippin’

Before things get totally burned out around here, it’s worth blasting what this whole Dow 20k joint really is.

The Dow Jones Industrial Average (DJIA) is a price-weighted index of 30 large “blue-chip” companies (mostly industrials) that are meant to be bellwethers for U.S. business market conditions.

The 30 component companies are:

  • Alcoa
  • American Express
  • AT&T
  • Bank of America
  • Boeing
  • Caterpillar
  • Chevron
  • Cisco Systems
  • Coca-Cola
  • Disney
  • DuPont
  • ExxonMobil
  • General Electric
  • Hewlett-Packard
  • Home Depot
  • IBM
  • Intel
  • Johnson & Johnson
  • JPMorgan Chase
  • McDonald’s
  • Merck
  • Microsoft
  • Pfizer
  • Procter & Gamble
  • Travelers
  • UnitedHealth Group
  • United Technologies
  • Verizon
  • Wal-Mart
  • 3M

And the whole “price-weighted index” thing means the Dow value is calculated by summing the share prices of each of these 30 companies and dividing by what’s known as the “Dow divisor.” That special number changes regularly to reflect stock splits, etc. to keep period-to-period comparisons of the DJIA value kosher.

All of which means the 20,000 level will be reached by the DJIA when the component companies’ stock prices collectively rise enough to be 20,000 times the value of the Dow divisor.

So, without too much taxation on your little canappa, you can figure out that the price-weighted formula over-emphasizes the impact of higher-priced shares relative to lower-priced shares. A company with a share price of $10, for instance, would have a lower impact on moves in the Dow’s value than a company with a share price of $600. (There’s a little more to it than this in the actual DJIA calculation, but the effect remains.) The overall market capitalizations of the companies (i.e., figures that might arguably be important for a stock index) are ignored in the calc.

And you already know that there are quite a few more than 30 companies operating in the U.S., hardly all of which are mega-corporations like Chevron and Microsoft.

And you already suspect where this discussion might now be headed.

“FL,” you say. “Isn’t the ‘price’ of a share of a company’s stock, without regard for the size of the initial share float, essentially irrelevant to the market capitalization and overall earnings power of that company?”

I guess it is, child.

“And FL,” you add. “Isn’t the price movement of 30 mega-cap companies’ shares a crazily small and heavily biased sampling of enterprises for drawing any meaningful conclusions about the broader business environment?”

I could be convinced that’s the case.

“And FL,” you go on. “Are you trying to tell me that the DJIA isn’t much more than a completely arbitrary number?!?!”

I’d hate to put words in your mouth. But if you wanted to circulate that thought like somebody’s homemade Buddha bong getting passed around a fraternity house living room, I’d hardly stop you.

“But, but, but, FL,” you stammer. “Is DJIA really useless?”

You wipe a single tear from the corner of your eye. It’s meant so much to you, this big and climbing figure. It’s not easy to say goodbye. So I put a reassuring hand on your shoulder just as soon as you complete the waiver, sign a consent form and pass your physical exam. (Can’t be too careful these days.)

And then I say unto thee: “No my child. DJIA isn’t completely useless. People still believe in it, after all. And that gives it power and value. Even if it isn’t any more real than the fake news headline telling you Dow 20k was predicted by the ancient Mayans and marks the end of the universe.”

Be Fallin’

Let’s put it this way: From one perspective, Dow 20,000 is no more and no less meaningful than Dow 19,853. Or Dow 20,116. Or pretty much any other Dow indica you can roll this way.

From another perspective, though, Dow 20,000 is much, much more important than Dow 19,853 and Dow 20,116. And even Dow 420.

The basic reason is that, despite being a pretty arbitrary measure of the U.S. stock market (which is a reflection of the U.S. business environment), the DJIA is widely known, readily observable, generally thought to mean something, and is thus profoundly psychologically important to most bakers and fiends out there. It simultaneously reflects sentiment about business conditions and informs it; it self-fulfills more than a pipe with an auto-reload feature.

Whether you believe in Buddha or the Mayans or Jesus or Yeezus or the tooth fairy is kind of irrelevant if everyone else smokes their stuff. Because, right or wrong, all those other bakers and fiends are gonna dictate how everything plays out.

If everyone believes it’s awesome to listen to Kanye West preach unintelligible tripe about his political leanings and latest fashion inspirations on stage just before getting checked into the only hospital in the world that specializes in ludicrous dye jobs, it’s probably not a smart business move to bet against Yeezus’s ticket sales.

And so it goes with Dow-zus.

“Yeezus, FL,” you curse. “Now are you trying to tell me that Dow 20,000 really is relevant?”

I’m trying to tell you that Dow 20,000 is exactly as relevant as Kanye West.

The entire flaming heap of Kanye West’s various enterprises depends entirely upon people believing he’s relevant. (It goes without saying at this point that, like many false idols, Yeezus is a vacant bag whose sole positive contribution to the universe is in helping reduce Kim Kardashian sightings on social media.)

If people stop smoking the Kanye chronic and start to look past West’s blank stare to see into the gaping chasm that is his actual value proposition…well, then you wouldn’t want to be staffed at the local hospital’s hair salon that day.

Same with Dow 20k.

Be Sprawlin’

And actually it’s the same thing with all stock prices all the time. Whether new information impacts stock prices has less to do with whether the business’s long-run earnings prospects are affected and more to do with whether peeps believe that others’ perceptions of fair valuation are affected.

That’s why “technical analysis” is even a thing. The whole field of technical analysis in equities is a total flim-flam, cult-like, smoka-thu-gunja dark trip that even Kanye West would probably question. But sometimes it actually does matter just because some people think it matters.

In that spirit, whether it’s a certain price level achieved by a stock (or index) or it’s headline news or whatever, there are at least three levels of inquiry relevant to any new piece of information regarding stocks:

Level 1: Does this info matter for the firm’s long-run earnings prospects, and thus share price, in the view of the single investor observing the new information? That is, does the information differ materially from what that single investor previously believed and is it accordingly already built into the investor’s “fair valuation” of share price? And, if not, what will the impact be?

Level 2: Do other investors think this news matters for the firm’s long-run earnings prospects, and thus share price? That is, does the information differ materially from what those other investors previously believed?

Level 3: Do other investors think this news will affect yet other investors’ perceptions of the firm’s long-run earnings prospects, and thus share price? That is, does the information differ materially from what investors perceive other investors’ perceptions of expectations were?

We could keep going, but it gets downright hallucinogenic past Level 4. And you get the idea anyway.

Be Bawlin’

So: Does Dow 20k matter?

Absolutely.

And here’s exactly the right way to analyze it: Will the DJIA’s eclipse of 20,000 cause investors to perceive that other investors view the price action as significant? And, if so, will investors believe that other investors view the price action as indicative of an improvement in psychological sentiment toward stock investment? Or will investors believe that other investors view the price action as indicative of a reason to become more pessimistic about stocks?

Naturally, if you believe the latter, then you have to ask the same question for Dow 19,999. And Dow 19,998. And Dow 19,997. And so on.

And, naturally, if you believe the former, you have to ask the latter question for Dow 20,001. And Dow 20,002. And Dow 20,003. And so on.

It’s more tedious than a conversation with Kanye West.

“FL,” you cry. “I’m so confused!”

And I say unto thee: “It’s probably all the kush, child.”

“What should I, like, do about Dow 20k? Man?” you say.

“Let me clear the smoke from your plaque-encrusted mind, child. You should, like, do nothing about it. Man.”

Free your mind around this: If you’re a long-term investor, you care as much about Dow 20k as Kanye West is likely to be taken seriously by anyone with a brain not fried like so much funnel cake. Which is right at zero. (And even if you’re not a long-term investor, Dow 20k probably isn’t something you’d want to build a trading strategy around.)

Dow 20k is a fun statistical and psychological phenomenon, and nothing else. On its own it doesn’t tell us anything about stock valuation, earnings, prospects, general investor sentiment, or really anything else.

At best, you’d say it’s a sticky icky historical indicator of how well 30 of the very largest American companies have fared over time. Kind of. After all, the 30 companies have changed. And the index is essentially arbitrarily weighted. And lots of important stuff isn’t accounted for. So maybe it’s just totally on the wrong end of a Sherman stick.

Which is precisely where you don’t want to be. So, child, I recommend you just say no to grass. Keep your head out of the hooch clouds, your nose clear of the Mary Jonas and your aural canals unburdened by the aimless chatter of Yeezus.

Dow 20k is just a flashing neon lamp that beckons the attention of Kanye West fans all slurred up on rangood and whack. And that ain’t you. So what should we do about Dow 20,000? Ignore the heads all shuffling toward the glow like so many zombies in a Scooby-Doo flashback. And you, fair child, you just stay away from the light.

Luchadores, do you know anyone who believes this Dow 20,000 thing is really important? What else might they believe?

28 Comments

Libre Your Mind