What Makes the Stock Market Tick, and is that an Alarm Clock You
Stock market analysts have an uncanny knack for confidently explaining why the stock market went up or down yesterday. But ask them to predict tomorrow's moves in the Dow Jones Industrial Average (the Dow) and they lapse into doubletalk.
I recognize that over the long run the market indexes tend to rise ahead of economic expansion and decline before an economic crunch. But, on any given day, the relationship is not clear-cut. As Nobel prize-winning economist Paul A. Samuelson pointed out: "The market has predicted nine of the last five recessions."
Many a day trader has learned that trying to time the market is a high-risk strategy. In a single day, the Dow has been known to gain over 14% but it has also lost as much as 22% between the opening and closing bell.
Given the enormous size of the Dow Jones blue chips, and barring a major event, you might expect the value of these companies to remain fairly constant between breakfast and dinner. After all, their combined market valuation is roughly $5 trillion (that's 5 followed by 12 zeroes, or the equivalent of $840 for every person on earth). Their combined annual sales are greater than the Gross National Product of all but the world's four largest countries. So why is the Dow so unpredictable?
First of all, the Dow includes only 30 of the roughly 12,000 publicly traded stocks in our economy. Second, the prices of the 30 Dow stocks are averaged without regard to each company's actual size. In other words, a company like Alcoa Aluminum counts for roughly the same as Exxon Mobil, which is six times larger, because their stocks trade in the same price range. Third, the DJIA excludes transportation and utility stocks, which Dow Jones tracks in separate indexes.
Other market indexes, such as the Standard & Poor's 500 and NASDAQ, include more companies and weight their share prices by company size. But they, too, can be unpredictable simply because there are many forces at work in the marketplace and they cannot be reduced to a single number on any given day.
For example, a company's stock price can rise over-night on news of increased sales and profits, new products, higher dividends, stock buy-backs, divestitures or take-over bids. It can also drop like a stone on news of war, natural disasters, industrial accidents, rising interest rates, inflation, disappointing earnings, changes in the foreign exchange rate, litigation and legislation. Add to all this confusion a certain amount of market churning fueled by speculation and rumor, and trying to time the market can have you lapsing into doubletalk, too.
In formulating an investment strategy, it's best to stay focused on the long term. Those who try to time the market often overreact to every dip or rise in the market, run up their trading costs and can generate extra capital gains taxes. Prudent investors recognize that, it's best to rely on time, rather than timing, in managing their portfolio. Always talk to your financial advisor when making any strategic investment decisions.