How To Follow the Stock Market… and Get the Big Picture

By Dr. Steve Sjuggerud, Chairman, Investment U
Tuesday, January 14, 2003: Issue #413

Are you watching the CRB? The T-bond? The Russell?

If you’re not, then you may be missing the big pictureand what’s really going on. Learning how to follow the stock market has its benefits. Most investors follow just the Dow, the Nasdaq and maybe the S&P 500. But just following those two or three indexes could lead you to POOR investment decisions without ever realizing it.

That’s because – with just those three pieces of information – you won’t have the right information to make informed decisions about the market. Today I’ll tell you about three simple – and quick – things you can do to make sure you learn and retain the right information Every Day. And I’ll also tell you why the Dow really isn’t a good stock market barometer to follow

What’s Wrong with the Dow

The Dow Jones Industrial Average–the stock market index that everyone talks about–is actually not a very good barometer of how the stock market works. If you’re just watching the Dow, you’re missing the overall picture. It’s not bad. But it has a few problems

• The Dow only has 30 stocks. If you really wanted an accurate representation of the market, you’d want as many as 500 stocks (the S&P 500 Index) or even 5,000 stocks (the Wilshire 5,000 Index, which now actually has 5,800+ stocks). Of course, they have to be the right stocks. The Nasdaq Composite is made up of around 8,000 Nasdaq stocks. But since the Nasdaq is so small, that only represents about 19% of the total size of all stocks. So it is not necessarily a good indicator either.
• The Dow is a price-weighted index. The 30 stocks in the Dow are not treated according to size, as you might expect. The higher the price of a stock, the more weighting it gets in the index. Here’s what that means Let’s pretend that the index was 29 stocks at $1 a share and one stock at $100 a share. If each stock fell by $1, that should be a catastrophe. Any other index would crash over 90%. But the Dow would fall from $129 to $99, not really representing the crash. That’s why a “price-weighted” index can contain misleading information.

In my mind a good index has a lot of stocks, is size-weighted not price-weighted, and is widely quoted and available. By that standard, the S&P 500 is a good stock market index.

The Important “Other” Indexes To Follow

There are three vitally important indexes – the CRB, the T-bonds and the Russell – that you should follow regularly to get a gauge on what’s going on. Keeping tabs on these three indexes doesn’t take a lot of time to do yet most investors would be much better off if they did. Let’s evaluate each in greater detail

Of these, T-bonds are probably the most important, as it is the primary benchmark of the cost of money in the entire world. When people say “T-Bonds” they’re actually referring to the 10-year U.S. Government Treasury bonds. Don’t pay attention when they say “T-bonds rose 13/32s today” just listen for what happened to the interest rate: i.e. “the yield fell to 4.13%.” Though it hasn’t been the case in the last three years (as we’ve been shedding the excesses of the stock market boom). As a general rule, stocks do well when interest rates are coming down, and they struggle in the face of rising rates.

The CRB Index is an excellent gauge of what’s happening in commodity prices, as it’s an index of a basket of 17 commodities. It includes metals, oil and gas, livestock and agricultural commodities. The index often moves in the opposite direction of bonds. Interestingly, the CRB index is up about 20% in the last year, signaling higher inflation and lower bond prices (higher interest rates) ahead.

The Russell is the benchmark index of small stocks. It’s actually the Russell 2000 Index. It’s important to follow nowadays because we’re coming out of recession and the worst stock market crash since 1974. After that crash, small stocks absolutely trounced large stocks, beating them nine years in a row, as reflected in the chart below:

As a rule, you should also keep your eye on the S&P 500, and what Greenspan does when he tinkers with rates. After that, if you know what T-bonds, commodities and small stocks are doing, you’ll have a pretty complete picture of how to follow the stock marketand what’s going on out there in nearly the whole investing world.

Good investing,

Steve

Today’s IU Crib Sheet

* As we stated earlier, the Dow is a decent – though flawed – stock market index but there are better indexes to follow. It’s worth an extra few minutes each day to keep tabs on T-bonds, the CRB and the Russell 2000. All three of these can be followed on the front page of http://www.barchart.com/. If you do that, you’ll be much better informed than most investors these days

* Of course – since I follow the stock markets for a living – there are a number of other indexes I track. Here’s a brief list of just a few that I like to follow (along with its symbol or web site)

• World Stocks: The World Index, available at www.mscidata.com
• Emerging Market Stocks: The Emerging Markets Free Index also at www.mscidata.com
• Real Estate stocks: The Morgan Stanley REIT Index (^RMS)
• A “Fear” Gauge: The “Vix” Index (^VIX)
• Gold: www.kitco.com
• Residential Real Estate: http://www.census.gov/const/www/  
• Commercial Real Estate: http://www.ncreif.org/indices/  
• Historical stock indexes: www.GlobalFinancialData.com
• Oil: www.nymex.com