I was speaking with a reporter at the Detroit News Wednesday about Dow 10,000 when he asked me whether now was a good time for people who had stayed out of the market during its run up from early March, when the Dow was at about 6,547, to put some money back into stocks. Is this a smart thing to do? How many people out there will view this milestone as a reason to buy? And what should these buyers buy?
Before getting into my thoughts on these questions, here's a story about why one person bought and later sold Apple Inc. (APPL). I was speaking to a guy last month who had read my March 5, 2008, post which said that if Apple -- which was then trading at $122 a share -- ever hit $100, it could be a buy.
This fellow remembered the post and when the stock hit $99 in February 2009, he bought shares. Unfortunately, it kept dropping -- hitting a low of $85 the next month -- before rebounding to $184, at which point he decided to take his profits, fearing that Steve Jobs might step down as CEO, crushing the stock. While Apple has since gone up further, he's happy with his profit.
What does this have to do with Dow 10,000? As far as I'm concerned, this fellow's story is a microcosm of why stocks go up and down. If you multiply his trades by the billions of others that happen around the world, you get half the explanation for why stocks rise and fall. The other half of the explanation would be to understand the reasons why the person who sold Apple to that fellow made the trade, and why the next person bought it when that fellow sold.
Since that information is not available, the media offers narratives every day to explain why the stock market has moved in whichever direction it has. And those narratives more often tell me about what the media does not know than shed any light on market dynamics. Here are some of the ones that have come up recently:• Retail sales are better than expected. I was listening to NPR's All Things Considered Wednesday and this was offered as the reason that stocks were rising. It was a somewhat tortured explanation since it involved stripping out the effect of the cash-for-clunkers program. And it just made me think that the reporter was searching for an "explanation" that would be easy for average listeners to understand.
• Too-big-to-fail (TBTF) banks. This is the idea that since the U.S. stepped in with $23.7 trillion in various cash contributions and guarantees to protect the biggest banks, investors realized that those banks would survive no matter how bad things got. This forced investors who had bet on those big banks going bankrupt to buy the stocks frantically to cover their short bets. TBTF may be good in the short term, but it's really bad in the long term since it rewards bad behavior.
• The market is forecasting an improving economy. This idea seems to be very popular. For example, The Washington Post points out that with unemployment so high, the Dow's 53 percent rise since March 9 is getting ahead of the economy. As I've posted, I agree that the economy is weak and could double-dip (this even before we're officially out of the current recession). But why people think this is connected to the stock market is beyond me.
• Better than expected earnings. This is generally a very reliable explanation for why stocks go up or down. As I posted in 2006, if a company beats estimates and raises guidance, its stock is likely to rise. And more importantly, if it misses estimates or lowers guidance, it is sure to plunge. Unfortunately, average investors can't play this because they don't have any way of knowing ahead of time what a company will actually report.
• Weak dollar. Recently, this has been a pretty solid trade. There appear to be many traders who are betting on a declining dollar and then buying commodities and/or commodity stocks as a hedge against the resulting inflation. Companies that get a big chunk of their revenues outside the U.S. also benefit from this trade.
Of all these "explanations," the weak dollar one seems most useful now. It suggests that big traders will keep shorting the dollar and going long on commodities. As I posted, some analysts expect faster revenue growth in energy and materials stocks, so those might be a good place to look. But in exploring particular stocks, it pays to compare their Price/Earnings ratios to their rates of earnings growth. If this so-called PEG ratio is less than one, the stock may be a better buy.
Of course, since so-called flash-traders -- whose computers get access to orders and trade a split-second ahead of them -- account for 70 percent of the market volume, all these bets are somewhat suspect.
And, according to The Washington Post, individual investors have not participated in this year's rally. They pulled $205 billion out of stock funds between September 2008 and the end of March 2009, when stocks began their rally -- at the same time, they poured $357 billion into money-market funds.
I would not be surprised to see some of those billions going back into stocks now. But I hope those small investors are not getting in just as the smart money exits.