Last month we wrote, "What happens to net short investors if the risk of recession recedes?  As we have seen, short-covering rallies are usually explosive to the upside."  Sure enough, we got a tiny hint of good news on jobs and manufacturing in the past couple of days, and US stocks rallied 5.3% in three days.  In a world where we think 8% annual stock market gains are reasonable, moves like that are ridiculous.  Worse, 8 months into the year, stocks are barely positive YTD.  Millions of individual investors are abandoning their stock portfolios, liquidating $44 billion in stock mutual funds through July 31st.  Meanwhile, $21.4 billion flowed into Equity Exchanged Traded Funds (ETF's), where investment analysis is replaced with simply buying or selling (or shorting) a basket of stocks without regard for the contents.  In other words, ever more investors are treating companies like fungible commodities such as crude oil.
 
Dow 10,000: the Industrials are still partying like it's 1999
US stock market history runs back 140 years.  Out of 14 decades of returns, only two decades (the 1930's and the 2000's) show negative returns.  The Dow Industrials first crossed 10,000 March 29th, 1999.  After the tech bubble burst, the Dow crossed 10,000 again December 11th, 2003, and traded sideways in 2004, crossing 10,000 on May 25th, July 27th, and September 28th,.  Finally stocks seemed to have wrung out the excesses of the late 1990's, rallying nearly 42% by October 9th, 2007 to 14,164.  Months later, Bear Stearns hit the wall, followed into oblivion by Lehman Brother 8 months

later.  By March 9th, the Dow was at 6,626, a decline of nearly 54%.  The Dow crossed back over 10,000 November 5th, 2009.  And now, nearly 10 months later, the Dow just crossed back over 10,000, again!  In other words, an investor who bought the Dow back in March 2009, ignoring dividends, has made exactly no money in 12 years!
 
History of the Dow Industrials
Serious investors generally use broad indices like the S&P 500 or the Russell 3000 for benchmarking.  Professionals do not use the  Dow Industrials because it is a poorly constructed and anachronistic benchmark.  Clarence Dow, later founder of the Wall Street Journal, created a "quick and dirty" index in 1896 comprised of 12 leading industrials of which only General Electric remains.  As this was the pre-computer era (or even pre-tabulating machine era) he simply added the stock prices of the original 12 components.  In other words, a stock of with a value of $10 that moved 50 cents would have 10 times the impact of a stock valued a $1 with a 5 cent move.  Modern indexes are market capitalization weighted, not price weighted, so a percentage move in a large cap affects the overall index more than the same percentage move in a small cap stock.  At present, IBM is the highest priced stock and accounts for 9.2% of the DJIA.  The lowest priced stock, Alcoa, is just 0.8% of the index. 
 
The other problem with the index is that a committee selects companies for inclusion (as opposed to market cap driving selection.)  While the index has long strayed from a pure industrial composite, the committee is notorious for picking companies whose stock price is about to peak.  In November 1999, the committee added these four stocks:

Strategy
Will there/won't there be a double-dip recession?  The consensus seems to be shifting away from "yes" to "maybe" to perhaps just a slowdown.  With federal tax credits for housing done, housing sales plummeted 26% in August.  To soak up excess capacity in construction, the Obama administration just proposed a $50 billion infrastructure spending plan.  Whether such a stimulus can be approved by a recalcitrant Congress two months before mid-term elections is of course a big question.  We already anticipate another round of excellent earnings in October and are maintaining our stock allocations in anticipation of an 8% year end return in the S&P 500.
 
Back to school offer
With Labor Day marking the unofficial end of summer and stocks rallying off the summer lows, now is a good time to review your investment portfolio and estate plan.  We have opened up 10 one hour slots in the month of September to perform complimentary portfolio reviews for prospective clients.  Call David Edwards at 212 595-9482 to set up an appointment.

                                                                   David Edwards
                                                                   President

The HERON FINANCIAL GROUP Financial Markets Commentary is published following month end and when market conditions require comment. The views expressed in this letter represent HFG opinion and strategy as of the date published and can change at any time upon receipt of new information. Data quoted in this letter are from sources deemed reliable, but no guarantee of such data is implied.

HERON FINANCIAL GROUP, LLC, is an SEC registered investment advisor providing fully managed investment and wealth management services to individuals, families, trusts, defined benefit plans and corporations.