Five Stock Market Pictures – Which One Is Right?

Friday, June 18, 2010

In the stock exchange art gallery hang five different paintings of this year’s stock market. Which one should we choose as being the right one?

How do investors view the US stock market’s performance this year? Judging by the media reports, the market is viewed as a losing investment with negative descriptors ranging from “volatile” to “dangerous.” And yet Thursday’s (June 17’s) Dow Jones Industrial Average (DJIA) close of 10,434 is virtually where the year began (10,428), not counting almost six months of dividends.

Why, then, the bad rap? The problem is the year began positively, setting up expectations. Then, mid-April hit, with loads of bad news (besides income taxes being due):

  • Euro begins its latest drop driven by Greek contagion concerns
  • SEC Sues Goldman for fraud
  • BP’s oil rig explodes
  • Afghanistan war reports begin in earnest, raising concerns

In spite of these items, the stock market held its ground through April’s end as better-than-expected earnings reports came in. Beginning in May, though, the negative news overwhelmed the good earnings, taking the US stock market down. Then on May 6 the US stock market blew a fuse.

Investors naturally got concerned. This worry turned to fear as bearish media reporting swelled, accompanied by unsubstantiated warnings of a second economic and/or financial collapse, the implosion of the European Union with the Euro being abandoned, and the contradictory visions of deflation and a worthless dollar. Predictions of another stock market crash of at least 20% reappeared.

Adding fuel to the fire was the speed of the stock market’s gyrations, not only daily, but also hourly.

The five faces of the stock market

In “Pitfalls in Today’s US Stock Market – Part 3” (May 28), I provided some suggestions for dealing with the stock market. Included was a discussion of watching the stock market less frequently – e.g., viewing each day’s close rather than the intraday prices. Further…

“Even better is maintaining a focus on weekly closes. Rarely are weeks made up of days that all move in the same direction. Plus, short-term traders usually close out their positions by Friday’s close to avoid the potential surprise “adverse” news over a weekend. So, the trend of Friday closes tends to be more informative than the daily ones.”

The stock market’s moves to date provide a good example of how less watching can provide more insight (and prevent emotions from sneaking into the investing process).

1. Daily range (high and low) plus close. This common graph shows all the noise in the stock market, during each day (the vertical lines) and day-by-day. Obviously, it looks like there is a lot of action. The media tries to provide fundamental reasons behind each move, but often the cause is simply investor activity (noise).

2. Daily close ignores the intraday movements. Day traders typically close out their positions by day’s end, so the closing prices exclude these short-term trading pressures. The graph is better than #1, above, but it still shows a lot of volatility.

3. Weekly close is my personal favorite for the reasons given above. I have tracked weekly moves throughout my years of investing and career and found they provided good information about the tenor and direction of the market. There is one exception that I circled: Two outliers that are typical end-of-trend (short-term) moves.

4. Monthly close shows less volatility again. However, there is not a strong, fundamental basis for choosing this period. Plus, months end on various days of the week, making the closes susceptible to short-term trading effects.

5. Quarterly close really minimizes volatility. While a quarter’s close can occur on any day of the week, fund managers often tidy up their positions then. They like to ensure their portfolios reflect their strategy since the holdings will be reported to shareholders. Also, because earnings are reported quarterly, there is a good fundamental reason for using these periods.

So… Take your pick. Use the period that best reflects your investing goals and portfolio approach. If you are a longer-term investor, then it makes little sense to watch the stock market’s short-term gyrations.

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