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As everyone knows, the Dow Jones Industrial Average has finally been setting new highs, almost seven years after the Jan. 14, 2000 high.

I was just perusing one of the pullouts (Mapping the Market's Wild Ride) in the latest Fortune Magazine issue, and I found it interesting that out of the 30 stocks that make up the average, 20 stocks are still lower than they were Jan. 14, 2000. 14 of the 20 are still down by more than 20% (and this doesn't take inflation into account).

Facts like this make me wonder how so many people can possible believe that the markets are efficient.
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14 of the 20 are still down by more than 20% (and this doesn't take inflation into account).

Nor the risk-free rate, at which the average stock is supposed to appreciate. That by itself, over 6.8 years, adds another 35% expected return (ignoring dividends) assuming a 4.5% risk-free rate over that time. So, those 14 stocks are down what, about 50%, from their 2000 levels vs. a risk-free investment. In efficient-market-land.

-Mike
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How does that say anything about the efficiency of markets? Could it not be that those 14 stocks, including GM for instance, are WORTH more than 20% less than they were 6 years ago?

d
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And what do you mean, "ignoring dividends"? If anybody thinks that is reasonable, feel free to send me yours...

The Dow Jones Industrial Average is meaningless times four:

1) It is not representative of U.S. businesses, and becomes less so every year.

2) It is weighted by per-share prices.

3) It ignores inflation (or "risk-free" rate of return; take your pick).

4) It omits dividends.

No serious or even half-serious investor gives a crap about the DJIA. If it were not for the idiot talking heads on the financial news, it would have faded into history long ago.

- Pat

P.S. "Journalism" is not a field of study. We get our news from people with a degree in nothing.
P.P.S. Happy Thanksgiving
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How does that say anything about the efficiency of markets? Could it not be that those 14 stocks, including GM for instance, are WORTH more than 20% less than they were 6 years ago?

d


What are the odds that two-thirds of the Dow stocks have intrinsic values lower than 7 years ago? What are the odds that nearly half have intrinsic values more than 20% lower than 7 years ago?
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No serious or even half-serious investor gives a crap about the DJIA.

Thank you, pat1729. I love you too.
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What does this have to do with market efficiency? FWIW a lot of the 30 stocks (or 33?) of the DJIA gain has to do with near bankrupt companies like GM seemingly coming back from the dead.

Also note that the improvement in the stocks might be due to a devaluation of the US$.

Stocks not doing much better than currencies:
http://finance.yahoo.com/q/bc?t=1y&s=FXE&l=on&z=m&q=l&c=fxc+fxs&c=%5EGSPC&c=%5EIXIC&c=%5EDJI
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The Dow Jones Industrial Average is meaningless times four:

1) It is not representative of U.S. businesses, and becomes less so every year.

2) It is weighted by per-share prices.


Item #2 is the one that kills me the most. I will never be able to figure that one out.
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MadCapitalist,

Forgive me.

How does the fact that 20 Dow stocks are still below Jan. 14, 2000 levels rule out market efficiency?

(:>)
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P.S. "Journalism" is not a field of study. We get our news from people with a degree in nothing.


"Journalist" students today are taught that they are to be public opinion makers and not reporters of the news. I am extrapolating my opinion based on actual quotes of professors to prospective journalism students.
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MadCapitalist,

Forgive me.

How does the fact that 20 Dow stocks are still below Jan. 14, 2000 levels rule out market efficiency?

(:>)


They were clearly overvalued in 2000.
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What are the odds that two-thirds of the Dow stocks have intrinsic values lower than 7 years ago? What are the odds that nearly half have intrinsic values more than 20% lower than 7 years ago?


Madcap,

What behaviour of stockmarkets would your require in order to believe that markets are efficient? Would you wish, for instance, for the Dow Jones to rise by 2-3% every year, in line with GDP? Would a year when the markets were up 10% be proof that markets are inefficient? Would any down year, in times when economic growth was positive, be attributed to inefficiencies?

I think that markets can go up a lot based on general optimism, without that being necessarily inefficient. After all, Buffett believes that a company's worth is the discounted value of its stream of future earnings, but those future earnings have to be guessed at with imperfect information. In 2000, everything seemed to be going so well, with a vibrant economy, peace in our time, technological progress, fiscal prudence from governments, etc. Pricing those elements into the assessment of future earnings made those companies 'worth' a lot more. Now, 7 years later, a lot of that enthusiasm has subsided, and the future earnings stream doesn't look so hot.

Efficient market theory does not state that markets can not go up and down, just that all those known factors have already been priced in. While we can easily see, in retrospect, that the markets were overly optimistic in 2000, it is not so certain that we could actually make money on that knowledge with the knowledge we had at that time. To me, Sept 11, a bungled war, rising government expenses and deficits, widespread corporate dishonesty (as shown in stock option practices), etc. make it reasonable that the stream of future earnings is worth somewhat less today than it was 7 years ago.

That the Dow Jones, made up of only 30 fairly non-representative stocks, is only a little higher than 7 years seems quite reasonable. That 20 of those stocks are down and 10 up does not surprise me too much, and that 14 are actually down 20% is also not surprising; the flip side is that 16 are up by around 20%, too. If dividends and inflation are a wash (I think that's reasonable), then I would say there is nothing in the Dow Jones to make me doubt the basic premises of the EMT.

Now the NASDAQ, on the other hand, would be a tougher argument. That was clearly a case of temporary insanity, perhaps revisited on a smaller scale today...

Regards, d

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>> What behaviour of stockmarkets would your require in order to believe that markets are efficient? Would you wish, for instance, for the Dow Jones to rise by 2-3% every year, in line with GDP? Would a year when the markets were up 10% be proof that markets are inefficient? Would any down year, in times when economic growth was positive, be attributed to inefficiencies? <<

Not necessarily. Overall market cap should be correlated with GDP growth but not directly.

Also, 2-3% GDP growth is in *real* (inflation-adjusted) terms and a 10% market return is usually expressed in *nominal* terms (not inflation-adjusted).

If you assume 3% inflation you'd see nominal GDP growth of maybe 6%. Conversely, if you look at real stock market returns, they're more like 5-6%.

#29
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Madcap,

What behaviour of stockmarkets would your require in order to believe that markets are efficient? Would you wish, for instance, for the Dow Jones to rise by 2-3% every year, in line with GDP? Would a year when the markets were up 10% be proof that markets are inefficient? Would any down year, in times when economic growth was positive, be attributed to inefficiencies?


No, not at all. My point is that the expectations for the future implied in the stock prices were *clearly* not reasonable. This is why the stock prices are still down 7 years later.

Please refer to Figure 1.3. Robert Schiller (author of Irrational Exuberance) calculated S&P 500 PE ratios (adjusted for inflation and using the 10-year average of historical earnings)
http://www.econ.yale.edu/~shiller/data/ie_data.htm

[For an explanation of the calculation methodology or to download the spreadsheet, go here:
http://www.econ.yale.edu/~shiller/data.htm]

Please explain to me how in the world our economy could have reasonably been expected to grow fast enough to justify a PE ratio of over 40, especially when the earnings were already at a high.
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Question: Please explain to me how in the world our economy could have reasonably been expected to grow fast enough to justify a PE ratio of over 40, especially when the earnings were already at a high?

Answer: The internetulip
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Answer: The internetulip

It took me four readings to parse this out and realize just how funny it is. Good one!

R:)
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Efficient market theory does not state that markets can not go up and down, just that all those known factors have already been priced in.

What efficient market theory does is this: it uses hindsight to prove it is always correct.

-Mike
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