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Dow Doesn't Deserve 17K?

|Includes:DIA, iPath U.S. Treasury 10-Year Bull ETN (DTYL), GLD, JNK, OIL

In an article titled "3 reason the Dow doesn't deserve to be at 17,000" (found here), author David Weidner outlines why "…the bull market in stocks is running for all the wrong reasons." The three reason that Mr. Weidner gives are lack of public participation, corporate earnings are flat and few alternatives investments for savers.

We actually believe the opposite is true, the Dow (NYSEARCA:DIA) is short of the mark in terms of where it could or should be based on historical precedence. On the topic of public participation, although Mr. Weidner is correct that the public isn't as active in direct ownership of stocks, an alternative view could be that when and if the public does get involved, usually the late stage in a bull market, the Dow could easily over-shoot on the upside by a wide margin.

In our March 13, 2013 article (found here), we pointed out that the average trading volume has been in a declining trend since June 2, 2009. Our concern was that with the decline in trading volume, indicating a lack of participation by the public, there may be a point at which stocks could not sustain their climb higher. We said the following:

"When the increase in volume arrives, the question then becomes, will there be a dramatic increase or decrease in stock market price? Will the general public's lack of participation be the catalyst that charges the market to move higher? This situation has to be resolved at some point."

As time has passed, we're starting to believe that if the public finally does begin to participate, even on a marginal scale, the stock market could effectively skyrocket.

Mr. Weidner's second point is that with corporate earnings being flat, there seems to be less of a justification for the stock market to move up as much as it has. However, the stock market usually works in mysterious ways when it comes to the impact of corporate earnings. As an example, the some of the biggest stock market gains are accompanied by lower than expected or declining corporate earnings and bear markets often coincide with exceptional corporate earnings. As an example:

"Right now, corporate earnings in the U.S. are very good. actually much better than analysts expected as recently as six months ago. But look at my Primary Trend Index (page 2 chart); it hit a new bear market low on November 4. Study the advance-decline ratio (which is a proxy for the action of all the stocks on the NYSE). The A-D ratio hit a new bear market low on the same day, November 2. Now check the daily new highs and lows. New lows have been coming in heavily, with day after day of more new lows than new highs (Russell, Richard. Dow Theory Letters. November 9, 1994. page 1.)"

The above commentary was during a period when the stock market traded in a range from August 1993 to February 1995.

"The word is out - corporate earnings in the period ahead will be leveling off or declining. Investors are switching to defensive shares (Russell, Richard. Dow Theory Letters. October 11, 1995. page 6.)"

The above commentary was during a bull market in stocks that saw the Dow Jones Industrial Average rise +144% from October 11, 1995 to January 10, 2000.

"The market is saying that corporate earnings are fated to decline, that price/earnings ratios are due to shrink and that business will be facing much tougher times (Russell, Richard. Dow Theory Letters. August 12, 1998. page 3)"

The above commentary was near the 1998 low and the Dow achieved a +24% gain by January 10, 2000 (excluding dividend reinvestment). Additionally, a new investment at the 1998 date would have gained +67% by October 2007 with only a -11.77% loss at the 2003 stock market low after the crash of 2000.

"The stock market, since August 1982 has presented us with four major lessons. Lesson I: The market has its own wisdom and it can move completely opposite to the obvious fundamentals. In August 1982, the fundamentals for the economy, the international picture and for corporate earnings looked terrible. And I'm not sure things have changed that much since late-1982 (except in the interest rate sector). But the market, despite this, surged to record highs (Russell, Richard. Dow Theory Letters. February 9, 1983. page 1)"

Since the above statement regarding the market from August 1982, the Dow has gained +1,209%. It is necessary to note the fact that Russell said "…The market has its own wisdom and it can move completely opposite to the obvious fundamentals…" This is huge and explains why we're choosing to adopt the view that maybe the opposite of what is expected will prevail.

Mr. Weidner's third point is that, "…there are no alternative investments…" and that the Federal Reserve's "…easy credit seems to be inflation in the stock market." The widely held view that the stock market has moved up due to Fed policy seems to miss the mark by a wide margin. As outlined in our article titled "Is the Fed Responsible for the Stock Market Rise Since 2009?" (found here), in the period when there was no central bank from 1836 to 1914, the stock market averaged a gain of +167% after large declines. If the Dow Jones Industrial Average were to rebound +167% from the March 2009 low, then the index would sit at 17,500.

Aside from the incorrect claim that the Fed is the reason for the stock market, Weidner goes through the list of "lacking" alternative investments. The first "investment" that is mentioned is fixed-income products like the 10-year Treasury (NASDAQ:DTYL). Yet, short-term treasuries aren't investments per se, they are savings instruments that carry the lowest risk available (aside from cash). Yes, short-term treasuries should have some role in your financial plan and can be beneficial in declining interest rate environments and market panics. Also, treasuries are a great place to park your money before the next big investment.

Weidner isn't interested in high yield junk bonds (NYSEARCA:JNK) because the issuance level exceeds what it was at the peak of the 2008 market. This assessment doesn't tell the full story since the junk debt market will continually increase in size. Simply stating that the market is two times higher than a select point in the past doesn't put the information into its proper perspective.

Weidner doesn't like housing because it seems to be a game for only the cash rich investors, however, this would fit the billing as an investment alternative to the stock market. After all, committed investors are putting real money on the line in order to secure real estate.

On gold (NYSEARCA:GLD), Weidner says that it is down -30% from the peak. That's it!!! Weidner has nothing else to say about a metal that is revered by many and is held in central banks around the world for some strange reason. Sounds like an opportunity to investigate the pros and cons of gold. Weidner doesn't go there and therefore confirms his view that there are no investment alternatives.

You'd think that Weidner would like oil (NYSEARCA:OIL), after all, it is only up by +20% in the last year. However, Weidner says, "…Nice, but it's still trailing the stock market." So, it would seem that if the asset is truly an investment, you should not have to compete with cash in the real estate market, gold is down so no interest there, oil is up so no interest there and junk bonds are being issued too much. All this leave a saver with no investment alternatives.

It is important to put the facts in a comprehensible order before making any claim. First and foremost, savers should only become investors when they are willing to accept the risk of loss. Once the acceptance of the risk of loss is established the many investment alternatives need to be examined in their proper context. Keep in mind that the stock market is adept at doing the opposite of what investors expect. Finally, from a historical standpoint, wider public participation in any investment always takes place in the latter stages of a rising trend.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Stocks: DTYL, DIA, GLD, JNK, OIL