Dow Jones is uniquely vulnerable

Several headwinds are staring the industrial average straight in the face.

By InvestorPlace Oct 25, 2012 12:49PM

Stock market copyright Zurbar, age fotostockBy James Brumley

iplogoOK, all you blue-chip fans, if your simple solution to holding the best (and presumably safest) names in the market is simply owning a basket of the Dow Jones Industrial Average's stocks, you might want to rethink things soon.

While the group remains one of the easiest ways to apply a long-term buy-and-hold strategy, the unique makeup of the index might be putting it face-first into its fair share of near-term headwinds.

Generally, a market index like the S&P 500 or Nasdaq-100 is designed to be a cross-section of the overall market, usually inclusive of all the stocks that meet certain size criteria. Therefore, that basket of stocks will largely mirror the broad market's sector and size stratification.

The Dow isn't your typical index, though. Its holdings are hand-picked, and more often than not, its represented sector allocation is considerably different from the overall equity market's sector allocation. It's also stock-price weighted rather than market-cap weighted, meaning even the sector groupings within the index aren't actually a snapshot of the broad market.

Nine times out of 10, it doesn't matter. Right now, though, is that one time out of 10.

None of the Dow's most heavily represented sectors are well-positioned for much -- if any -- upside in the foreseeable future.

Breaking It Down

Click to Enlarge

The expandable table to the right sets up part of the pessimistic story. In no particular order . . .

Industrials: They might make up 20% of the Dow's total value, but they sure don't make up 20% of the U.S. market. Indeed, very few American companies actually "make" anything anymore.

That wouldn't be that big of a deal for the Dow Jones Industrial Average were it not for one thing: Its five components that are considered industrial stocks have been waving red flags for the bulk of third quarter's earnings season so far. Caterpillar (CAT), for instance, recently cut its full-year forecast for the second time this year, citing a measurable economic slowdown. 3M (MMM) also cut its full-year earnings forecast, hitting a big wall in Europe. Boeing (BA) is an encouraging exception, but the airplane maker can’t carry all the weight.

Financials: The financial sector actually is a bit underweighted in the Dow. Perhaps more important right now, however, is that financials have been one of only two sectors doing the lion’s share of the lifting for the Dow this year. That presents a problem, though, as many of these stocks have gotten a little ahead of the underlying companies, and have little room left to run higher. Add in the fact that Bank of America (BAC) is now facing a $1 billion lawsuit from -- and this isn’t a typo -- the United States government for mortgage fraud. That's 3.3% of the Dow right there, represented by a company that wasn't doing all that well to begin with.

Health care: The only other sector that's actually helped the Dow this year is also now strained and/or overbought as a result of doing so. And as you can tell, none of those pharma names are expected to light it up next year in terms of earnings growth.

Technology: Did any of these names do well (so far) this quarter? Microsoft (MSFT) fell short of Q3 earnings estimates, Hewlett-Packard (HPQ) is battening down the hatches in an effort to survive the looming PC-sales implosion, and International Business Machines (IBM) -- the rock of rocks within the technology world -- fell short of revenue estimates in Q3. It's the fifth consecutive time IBM missed the projected top line. It wouldn't be a huge deal, since we're getting used to the revenue miss, were it not for one thing -- this was the first time sales actually fell on a year-over-year basis. That's a big red flag. (Microsoft owns and publishes Top Stocks, an MSN Money site.)

Telecom: From a distance, AT&T (T) and Verizon (VZ) look perfectly healthy. In fact, they've both been so red-hot this year that many Dow investors might be wishing for a bigger telecom allocation for the DJIA. But neither name has left itself any wiggle room. Both trailing price-to-earnings (P/E) measures are in the 40's, and the forward-looking P/E ratios are in the teens as both telecom players expect the iPhone 5 to crank up wireless revenue while the landline business is bolstered by newly forged partnerships with several cable television companies. If any part of that optimistic forecast isn't met, though, traders aren't apt to hold onto stocks that are so richly valued. (In fact, they already might be fairly valued at their maximum earnings capacity for 2013.)

You get the idea, and it's not like energy or basic materials or consumer services -- at least not the ones in the Dow -- are in any position to help.

But wait. It gets even worse.

Technically Speaking …

Click to Enlarge

As if the Dow Jones Industrial Average's holdings weren't hitting a wall on their own, collectively, the index also is showing us a little too much technical weakness.

As of this week (and for the first time since July), the Dow Jones Industrial Average is trading beneath its 50-day moving average line (purple). As of Wednesday, the index is even putting some bearish pressure on the 100-day moving average line (gray). There's still a chance it could find support at the 100-day line and bounce out of this mess, but after falling under the key support line (black) that had been propping it up since July's bottom, why would the Dow find support here?

The last bastion of support/hope is the 200-day moving average line at 12,977 (green), which just happens to be intersected with the lower 50-day Bollinger band (orange) at this point in time. The bears have momentum, though, and if the 200-day line fails to act as support, it could be the beginning of a selling avalanche.

Add it to the list of things wrong with the DJIA right now.

Then again, considering a "normal" bull market correction is on the order of 9% -- and that we've only stumbled 4.2% thus far -- maybe it's just what the doctor ordered.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

More from InvestorPlace

Oct 25, 2012 1:53PM

I can’t believe I am saying this, I bought into “Hope and change” last time, really hoped President Obama was going to change things, couldn’t have been more wrong. This time I am going for “Change and hope” Mr. Romney knows more about turning a bad financial problem around than anyone, and dealing with the rich. It is what he does and like it or not he is very successful at it. Just hope he does the right thing for all of America, not just the rich and the GOP. America doesn’t need any more front men from either party. We need a real leader a president for all of America.

P.S Probably going to be wrong again wish I had another choice that was viable.       

Oct 25, 2012 1:19PM
The "hopeium meme" of the last 4 years is just about totally exhausted.
Oct 25, 2012 1:42PM
Oct 25, 2012 2:48PM
As a small investor, I am completely confused.  I am not sure of the present leadership and fearful of the potential party of no specifics.  I am really fearful of the market and the 2nd in command if the new alternative is elected.  My mind tells me it is not time to "take my money and run" ; however, my gut does.  I am too close to retirement to lose it all and I am fearful of that.  Can I wait and see what happens in November?
Oct 25, 2012 1:30PM
Blah.  Blah.  Blah.  And here's my charts and my predictions of the future.  Predicting the future of anything is difficult.  Whenever someone is saying the market is ready to fall, it could easily be ready to rally.  And vice versa.

Stock markets do tend to rise over time, but decades-long periods of stagnation can easily occur with no real way to predict them.  Short-term market predictions often are totally meaningless. 
Oct 25, 2012 2:25PM
I'll take my chances , thank you . You guys have all kinds of advice but always ignore the obvious - Dividend stocks have averaged over 11% per year return on the long haul - I'm sticking with my strategy and you go with yours - Good Luck !
Oct 25, 2012 4:25PM

The Dow has hit a wall and the $@*& will hit the fan if Obama gets elected again.


This country MUST get a leader who understands business and economics.  While all of our problems  certainly cannot be solved by a new president, a more robust economy which is adding jobs and creating opportunities for the gain of wealth is the first step in improving the overall big picture.


Go Romney/Ryan and Go USA!!!!!!!

Oct 25, 2012 3:49PM
Petemoss said;
"You cant fix a massive recession in 3 1/2 years....he has fixed A LOT though"

Then why did he say he would?
Oct 25, 2012 3:53PM
the Dow has hit the wall??? more like America has hit the wall, BIG TIME!!!! and it took a black marxist loony toon to slam her into it!! FORWARD right into the wall, light speed!
Oct 25, 2012 4:55PM
Shouldn't we blaming our PITIFUL economy on some obscure youtube video????
Oct 25, 2012 2:17PM
i guess it IS time to gather my chips and walk away from the table. but it was such a lovely run.
Oct 25, 2012 5:22PM
Oct 25, 2012 5:04PM
I think that they write articles that will encourage and then the next day discourage so that when something does happen, they can say they predicted it long ago. 
Oct 26, 2012 4:15AM
Do you own your own home? Romney said tonight he was going to eliminate the write-off on your taxes for home mortgage interest. That's just the beginning of the end for the middle class but there will be no tax hikes or anything done to the rich. Why should somebody who paid their mortgage on time all these years be penalized by Romney for the criminals who lied to get a mortgage and so Goldman Sachs could sell junk bonds based on fraudulent mortgages and get richer? Why should I lose social security or medicare because the GOP lured 40 million illegals in to get amnesty so they could get their votes?Wake up before it's too late.
Oct 26, 2012 4:26AM

Romney isn't that smart. Early voting is going on so he decides to announce he will eliminate the deduction for mortgage interest. Dumb move which will result in fewer people wanting to own homes.

Why are certain Americans so willing to overlook the horrors this man will inflict on the middle class?

An awful lot has gone right in the last four years and with more time and over time the budget will be fixed without the help of the do-nothing Congress. Interest rates are the lowest in history for those wanting to buy a new home, a car or finance an education. If you have lost your job re-educate yourself. If you are young enough, enlist and serve our country until the economy is better. Whatever you do, please do not put this fanatical liar into the White House. VOTE OBAMA!!

Oct 26, 2012 4:37AM
Now I know who is holding up traffic on the roads;it is the Democrats since, they have no since of direction. They think Obama is leading this country forward when in fact he is the beginning of the end of a once great nation. He is driving this country towards a Socialist Welfare State, at a cost that no economy can sustain. The deficit he has dropped on this country can't be denied,and the only budget he has for this nation is an "unlimited" one,which can only lead to economic disaster. The stock market will drop like a rock, or at best just muddle around, unless someone stops this lunacy. The only certainty we can expect  are taxes and more taxes,on all things. Costs will go up,buying power will go down, and business will go bust and more people will be on the dole. There is one thing we can look forward to with four more years of this administration,and that is more dishonesty,deceit and cronyism. I'm putting my money under the bed.  
Oct 26, 2012 1:46AM

When the big banks and Wall Streeet melted down after the housing buibble, and had to be bailed out to the tune of hundreds of dollars by the Fed, we had welfare for Wall Street. One estimate had the average household losing 38% of its net value.   This was the bigest banking crisis since the great recessin of the 1930 s.  Put the blame where it belongs on the greed and foolishness of mortgage lenders,,big banks and the lax regulation that permitted this massive fraud and wild speculation. Do you really think that this could be repaired quickly and easily?

Do you really think the solution is just to deregulate everything and put the same people and same policies back that got us into this huge mess?

  The republicans hve the same motto as the cynic H. . Menken.  "No one ever went broke underestimating the intlligence of the American public."



Oct 25, 2012 5:12PM
This article assumes that the hand "pickers" won't realize the same things and change the selection, in order to effect the unscrewing..
Oct 25, 2012 7:37PM

I think some of you Republicans need a math class.When Obama took office the

Dow was at 8158.It`s up about 5,000 points, about 61%.Some of these bearish

GOP guys act like it`s down 80%.These are the good old days with Obama.61%

before dividends added is big time.If you`re an investor you`ve got to absolutely

love Obama.Give Rush and Ann Coulter and Hannity some exlax.VIVA OBAMA.

Oct 25, 2012 7:48PM

Maybe in Obama`s second term these right wing NAZIS will learn to spell Obama`s

name.Then again, spelling is hard for those that went to school in short yellow buses.

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