Little White Lies


"History shows what actually makes money and what constitutes risk."

"Pure truth, like pure gold, has been found unfit for circulation because men have discovered that it is far more convenient to adulterate the truth than to refine themselves." -Charles Caleb Colton
I very seldom write for general consumption but, given the amount of misinformation (i.e., lies being spoon-fed to the investing public), I feel the urge to speak out. You'll have to excuse me if the niceties of the English language sometimes escape me, but I guess I'm more into function than form. The subject of my disgruntlement is specifically the Dow and generally how it is presented to the public.

I remember hearing the mantra "buy and hold" when I was a kid back in the early '60s and my grandfather, a product of The Great Depression, would just wince. I never understood that until the stock market turned sour way back in 1999. In order to get a handle on reality, I want to go at it from a different angle, stepping back away from the everyday chatter, to take a look at a couple of historical charts. There is a lot of misinformation about what makes money and what doesn't, and about what constitutes risk and what doesn't. I think, if we focus our attention on months and years rather than minutes and hours, we may actually learn something.

One of the so-called market truths I want to look at is the idea that stocks go up over a long period of time, so you simply buy stock and put it away for safekeeping to make money. They point to how the Dow has risen over the decades as proof that stocks are a good long-term investment. Simply put, that's a big lie! What follows is a list of the original 12 Dow stocks:
  • General Electric: Exists today under the same name;
  • American Cotton Oil Company: A predecessor company to Bestfoods, now part of Unilever;
  • American Sugar Co.: Became Domino Sugar in 1900, now Domino Foods, Inc.;
  • American Tobacco Co.: Broken up in a 1911 antitrust action;
  • Chicago Gas Company: Bought by Peoples Gas Light in 1897, now an operating subsidiary of Integrys Energy Group;
  • Distilling & Cattle Feeding Company: Now Millennium Chemicals, formerly a division of LyondellBasell, the latter of which is now in Chapter 11 bankruptcy;
  • Laclede Gas Co.: Still in operation as the Laclede Group, Inc., removed from the DJIA in 1899;
  • National Lead Company: Now NL Industries, removed from the DJIA in 1916;
  • North American Co.: An electric utility holding company, broken up by the SEC in 1946;
  • Tennessee Coal, Iron and Railroad Co.: (Birmingham, Alabama) bought in 1907by U.S. Steel prior to its bankruptcy filing;
  • US Leather Co.: Dissolved in 1952; and
  • United States Rubber Co.: Changed its name to Uniroyal in 1961, merged with private B.F. Goodrich in 1986, bought by Michelin in 1990.
Of the original 12, 7 were bankrupted, dissolved or delisted; only one, General Electric exists today in its original form. United States Rubber Co., later known as Uniroyal, was a distress sale as was American Cotton Oil Co. The point I am trying to make here is that companies are no different than human beings—they are born, if they're lucky they grow up, grow old and they die. Dozens of companies have moved into the ranks of the Dow over the last 100 years, dozens have fallen from the ranks, too; and they would have taken your hard-earned dollars with them if you had held onto their stocks.

Recent history isn't any better. Take a look at the current list of Dow stocks:


Notice the emphasis on the word current. I do that because these weren't the Dow 30 stocks ten years ago. Below I have a list of the Dow stocks that were weeded out over the last decade:


Before I delve into today's Dow I would like to discuss an overworked term known as value. Way back in 1898 Charles Dow mused that stocks were a bargain when the PER for the Dow approached eight and the average dividend hit six percent, and inversely stocks were expensive when the PER hit seventeen and the average dividend fell below three and a half percent. This thinking remained the norm until Greenspan took the stage and our public servants began manufacturing bubbles. Using Dow's ruminations as a guideline, stocks were last considered to be cheap in 1981. Using past earnings as a guideline stocks have been overvalued since the mid-1990's and has never been cheap. So when analysts too young to know or care who Charles Dow was get on TV today and espouse that stocks are cheap, they are blatantly and stunningly full of manure. Throw into the mix that most of the balance sheets of major entities, especially financial entities, are fraudulent representations of reality and you can see that we have a problem.

Now let's fast forward to the last decade and see what would have happened if you bought the list in the year 2000. In the first place you would have suffered significant losses with General Motors, AIG, Bank of America and Citibank as they became penny stocks. Verizon, Cisco, and Intel also suffered as a result of the "tech wreck" that started in late 1999. Now I'll go so far as to assume that you possess special powers that allow you to see into the future and you knew in 2000 what stocks would have made the list in 2009, you still would have lost money. Take a look below:


The Dow was worth roughly 11,725 at the beginning of 2000 and on Tuesday it ended the session at 10,340. In case your math skills are a bit rusty, it means that you would have lost 11.66% over the last decade and a year. Not exactly the stuff legends are made off!

As if that wasn't bad enough, the news gets worse as you dig a little deeper. Unfortunately when you buy stocks in the US market, their value is denominated in US dollars. Now let's take a look at what happened to the value of the greenback over that same period of time:


The spot U.S. Dollar Index, the value of the dollar measured against a basket of other currencies, fell from $118 to the current price of $82.76—and that is a significant haircut no matter how you spin it. It's a small, seemingly innocuous detail that most analysts leave out of their sermons. So tack on another 29.99% loss in real terms to the 11.66% decline mentioned above, and you're on your way to the poor house.

For the "here and now" crowd, of which I am not a member, things don't look like they'll improve anytime soon. Below I have inserted a 6-month daily chart of the Dow, with some highlights:


Here you can see that the Dow has been busy of late building a head-and-shoulders formation complete with two sets of shoulders and two necklines. I believe that last week's rally completed the final and biggest right shoulder at a level just under the larger of the two left shoulders. What's more it failed to penetrate the 200-dma, which continues to trend well above the 50-dma. If Friday's closing high of 10,447.93 continues to hold, it means that the Dow rallied seven days off of the August 26th closing low of 9985.21, recovered slightly more than 61.8% of the preceding 783-point decline over 13 days and turned down.

As reactions go, it is neither strong nor weak, but middle of the road. The decline that began with Tuesday's 107-point drop to 10,340 should mark the beginning of a significant move lower that will test the July low and strong Fibonacci support at 9,706.46. I do not expect that low to hold this time around—the urge to sell will increase, and we'll make significantly lower lows as we head into the fall.

In conclusion, everything is possible over the short run. We are heading toward a midterm election, and the Fed could inject money directly into the markets to pump things up; but that doesn't solve the problem. The real problem is debt and there are only three ways to deal with it: Cut spending, increase taxes or write it off. We have a huge overhang of debt and a very narrow tax base. None of the above is a palatable solution for either political party, so the problem festers like a cancer. I will take this a step further and say that debt now has taken on a life of its own so spending cuts and tax increases are not long-term solutions.

Writing debt off is the only real solution and that means there will be some big losers. In order to avoid damage to the privileged financial sector, the Fed has been busy transferring debt from private institutions to the public sector (you). Unfortunately, the Fed has no real assets so it prints fiat currency (i.e., more debt) in order to fund the transformation. All of this will have to be washed out of the market and, given the gross distortions that exist, it will involve considerable pain. The only question is when. The longer it takes the more pain involved.

I want to be up front and say that I manage two types of portfolios for small investors: Short the Dow or long gold. Therefore, I have a vested interest in the direction of the Dow and you need to be aware of that when you read this report. Should you have any questions about my analysis or about investments, I can be reached at: [email protected]. I will try to respond to your questions in a timely manner.

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