September 25, 2012

The Markets: Dividends and Dow Theory

Corporations are putting more cash in investors' pockets.

In the past week, more than half a dozen Blue Chip companies announced increases in their dividend payouts. In fact, Standard and Poor's Corporation said S&P 500 companies paid a record $34 billion in cash payments to investors in August. That's a pretty nice stimulus!

And, the largesse may continue. Howard Silverblatt, an analyst from Standard and Poor's, was quoted in MarketWatch as saying, "2012 should set a record high for cash dividend payments, 16 percent above that of 2011."

While dividend payouts look good, another part of the stock market is "diverging" and sending mixed signals.

There's a century old investment management system called "The Dow Theory" which was developed by Charles Dow through a series of editorials in The Wall Street Journal between 1900 and 1902. According to this theory, in a healthy stock market, the Dow Jones Industrial Average and the Dow Jones Transportation Average should rise in sync.

The theory is based on the idea that companies in the industrial average "make the stuff" while companies in the transportation average "ship the stuff." If there's a divergence in the movement of the industrial average and the transportation average, then you have to wonder which one is potentially giving a misleading signal about future economic activity.

So, what's The Dow Theory signaling now? It's flashing red because, as of last week, the Dow Jones Industrial Average was up about 11 percent for the year while the Dow Jones Transportation Average was down more than 2 percent. And, just last week, the industrial average was flat while the transport index dropped a significant 5.9 percent - a substantial divergence in just one week.

Like all investment systems, though, The Dow Theory is not foolproof and this divergence could just be noise. In any case, it's worth keeping an eye on it as a possible early warning sign.

Data as of 9/21/12	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	-0.4%	16.1%	25.2%	11.1%	-0.9%	5.8%
DJ Global ex US (Foreign Stocks)	-0.8	10.1	8.6	1.6	-5.6	7.9
10-year Treasury Note (Yield Only)	1.8	N/A	1.9	3.5	4.6	3.7
Gold (per ounce)	0.5	13.3	-0.5	21.4	19.4	18.7
DJ-UBS Commodity Index	-2.9	5.0	-4.1	5.7	-3.6	3.3
DJ Equity All REIT TR Index	-3.1	17.5	31.1	19.9	2.8	11.4

CAN YOU IMPROVE YOUR INVESTMENT PERFORMANCE BY TAKING A TRIP to the local drugstore and forking over two dollars to buy a spiral bound notebook? Yes, says Nobel Prize winner Daniel Kahneman, one of the country's preeminent psychologists.

In a recent conversation with Tom Gardner of The Motley Fool, Legg Mason Capital Management chief investment strategist Michael J. Mauboussin recounted a conversation he had many years ago with Professor Daniel Kahneman. Mauboussin asked Kahneman this question - What single thing can an investor do to improve their investment performance? Kahneman said buy a notebook and when you make an investment, write down why you made the investment, what you expect to happen with the investment, and when you expect it to happen.

Hmm. How does that translate into improved investment performance?

As humans, we often succumb to what's called "hindsight bias." Hindsight bias means we tend to think our forecasts were better than they really are. For example, few people predicted the severity of the Great Recession, but, after the fact, many people said they saw the signs of a bubble about to burst. These people "misremembered" what they were thinking prior to the Great Recession.

Kahneman says writing down what you're thinking and what your expectations are - at the time you make an investment - allow you to go back after the fact and see how accurate you were. This black and white analysis helps keep you honest about your ability to make predictions and make good investment decisions. It helps you avoid becoming overconfident. Overconfidence is bad because it makes you think you're smarter than you really are which could lead to making riskier investments and losing lots of money.

Sometimes the best ideas are also the simplest.

Weekly Focus - Think About It...

"Well, I think we tried very hard not to be overconfident, because when you get overconfident, that's when something snaps up and bites you."

—Neil Armstrong, astronaut, first person to walk on the moon

Best regards,
Sean M. Dowling, CFP, EA
President, The Dowling Group Wealth Management

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