Opinion and Investing Column

SKARBECK: Don't get overly excited about new index records

March 9, 2013

Ken Skarbeck InvestingIt might have crept up on investors, but nearly four years to the day after the stock market sank to a credit-crisis-induced low on March 9, 2009, the Dow Jones industrial average reached a record high. The Dow bottomed out at 6,547 back then, and closed at 14,254 on March 6.

Right on cue, the media made sure this feat of market history was front-page news. The television airwaves were filled with pundits offering sound bites as to what this all means for investors.

The frenzy surrounding a new market high tends to raise the blood pressure in investors. It seems to stimulate a feeling that they need to “do something.” Should we buy? The rising market seems to be predicting good times ahead. Should we sell? Maybe stocks are too high now and it would be wise to take some money off the table.

Our recommendation to investors—with a nod to “The Wizard of Oz”—is to “pay no attention to the man behind the curtain.”

That man could be the voice in your head prodding you to take action, or he could be one of a plethora of pundits who will offer their predictions about where the market is headed. While they might sound convincing in their forecasts, such short-term prophecies are analogous to a dice roll. There is certainly no need to make drastic changes to your portfolio just because an index reaches a record.

Actually, the new stock market high is itself deceiving. Of the 30 stocks in the Dow, 12 are still down from their individual highs. Laggards include Cisco Systems, Alcoa and Bank of America. On the other hand, just five stocks have accounted for more than one-third of the increase since March 2009: IBM, Caterpillar, 3M, Chevron and United Technologies.

Noticeably, the Standard & Poor’s 500 is still 2 percent below its all-time high. The divergence between the Dow and S&P 500 can be attributed to the way each index is calculated. Suffice it to say the Dow is a “price-weighted” index of 30 stocks, whereas the S&P 500 is a “capitalization weighted” index of 500 companies. It’s worth noting that Apple is not part of the Dow, yet is the largest company in the S&P 500. Despite their differences, the two indexes tend to track each other over time.

Of most importance to investors: Market valuations today are cheaper than the last two market peaks. Today, the S&P 500 index is trading at about 13.5 times estimated earnings, a benchmark known as the PE ratio. At the last high in October 2007, the market’s PE ratio was 15; it was 30 during the bubble in 2000.

So while stocks have recovered nicely over the past four years, they still appear to offer good value, particularly when compared to bonds or other fixed-rate investments.

Investors should be focused on the specifics of the companies they own and not the index.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
 

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