Friday, 20 February 2009

Slow motion crash - getting even slower

The current market action is giving an even subtler dimension to the notion of a slow motion crash. The DJIA closed at its lowest level in more than six years and the financials continue to get pummeled but there seems to be a rather stoical and mild mannered response to it all. Part of the reason has to do with the way in which the Dow Jones is calculated

The Dow is a price-weighted index where the higher the stock price, the more it affects the index’s value. As many financial companies have plunged in value, the Dow is littered with sub-$10 stocks that have little impact. Consider that Bank of America (BAC), Alcoa (AA), Citigroup (C), General Motors (GM), and General Electric (GE) have a combined weighting of 2.9%. If all five were to go bankrupt the U.S. economy would be devastated, yet the Dow would fall only 220 points.

The S&P 500, which is market cap weighted is not quite at multi-year lows but a rendezvous with 750 looks almost inevitable. If that breaks I suspect that we could be looking at 680 in a hurry. Many learned analysts from a more fundamental perspective are making cases for 600 or thereabouts on the S&P 500 based on P/E ratios but the enigma at the moment is trying to make any kind of convincing case as to what the E part of the formula is going to be this year.

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