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Is Dow Jones a big bubble?

by das monde Tue Sep 1st, 2009 at 06:32:46 AM EST

I did the exercise of downloading Dow Jones IA historical data from Yahoo Finance pages, and plotted the weekly closing DJIA values:

I thought that I saw these graphs, but I am struck by the overall shape. The right-hand side of the picture looks completely different from the "lethargic" middle and left parts. What kind of common parameters of economic goodness or random walk could fit the whole graph?

We can recognize that the Great Depression recovery was long, or that there was a mysterious deflation in the 1970s. But the growth rates since the 1980s do not look like anything of the previous 50 years.

Diary rescue: orginally posted August 20 - Nomad


For a balanced perspective, it is worth to take the index values in a logarithmic scale:

We had a roughly 10-fold growth in 30 years of recovery from the Great Depression, then a flat period of 20 years, and then a 10-fold growth in 20-30 years again. Does it make a good real-world economic sense?

DJ 14000 was just 100 weeks ago, by the way.

Display:
I take it these are not inflation adjusted?

Hey, Grandma Moses started late!
by LEP on Thu Aug 20th, 2009 at 03:25:18 AM EST
Yes, these are not inflation adjusted. Can we say that we had 3 periods of different inflation?
by das monde on Thu Aug 20th, 2009 at 03:28:13 AM EST
[ Parent ]
The inflation adjusted picture is somewhat different, and much less vertigo inducing: We are now at ~1966 levels (first reached again in the mid 90s) and not that far away for the 1929 peak...




The road of excess leads to the palace of wisdom - William Blake

by talos (mihalis at gmail dot com) on Tue Sep 1st, 2009 at 06:18:42 PM EST
[ Parent ]
So if I understand this correct, inflation was pretty big during the eighties?
by Nomad on Wed Sep 2nd, 2009 at 06:40:33 AM EST
[ Parent ]
More like the 70's - 1965 to 83.

This chart captures stagflation: the nominal value stayed roughly constant but inflation was high.

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma

by Migeru (migeru at eurotrib dot com) on Thu Sep 3rd, 2009 at 09:05:51 AM EST
[ Parent ]
Is Dow Jones a big bubble?

Yes.

This has been another edition of Simple answers to simple questions.

On a more serious note, it becomes easy to see why the Raygun Revolution fell on more fertile soil than similar insanity had managed twenty years prior.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Aug 20th, 2009 at 03:30:55 AM EST
A turning point in the 1980s is very well visible from this known graph:

It was easy for Wall Street to be fertile then. But all the ground and fertilizers are probably wasted by now.

by das monde on Thu Aug 20th, 2009 at 05:02:10 AM EST
[ Parent ]
because of the hippies and increasing rates of divorce and abortion, which reduced the size of families - and liberal lifestyles which further encouraged  lack of commitment and smaller households...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Aug 20th, 2009 at 05:34:12 PM EST
[ Parent ]
Loosers, those median families </snark>
by das monde on Thu Aug 20th, 2009 at 10:53:19 PM EST
[ Parent ]
never did like median families myself.  It's the 2.2 children that really caused me a problem.

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Sep 1st, 2009 at 07:47:32 AM EST
[ Parent ]
A comment I already made a long time ago: DJIA is a crap index, technically speaking, for two reasons:

  • it is price-weighted, instead of capital-weighted (that is, it gives more weight to shares with a prices than to shares of a economically more significant companies)

  • the sectorial mix / inclusion criteria are purely discretionary, including in frequency.

By contrast, S&P 500 is a lot less volatile, and not only because there are more shares: it is just a "top floats" list with sectorial cappings, making it objective, automatic, and a statistically significant sampling of the value of large corporations in America.

Because of these crappy characteristics, the DJIA "over-crashed" following the Depression (if S&P had existed, it would not have been divided by 10, may be just by 3 or 4). That is because bubble stocks were overweighted before the crash, and tiny caps were not replaced soon enough by resistant companies. At the time, DJ publishing company was not sophisticated enough to game the index.

But in the Raygun era, DJ became clearly aware of the public fixation on DJIA, and the ease with which it could be tampered without questions. The outdated formula became a feature, not a bug: you can manipulate the public perception of the performance of the stock market, by cherry-picking the DJIA companies, and by arranging for the "right" companies to perform/not perform stock splits.

Go googling across the web, you will find several articles from around 2007 explaining you that at the peak of the last bubble, the index looked 30% higher than in the dotcom area, when actually 20 out of 30 member companies in it where actually 30% lower than in 2000. Had it been cap-weighted with automatic replacement between 2000-2007, the DJIA would have been may be 10-11k instead of 14k at the peak (that is, a lost decade).

Pierre

by Pierre on Thu Aug 20th, 2009 at 08:12:18 AM EST
At some time, the public indeed became abusively manipulated with select crap statistics, hyped pundits and indicators, tabloid sensations. That was apparently very useful for "hard-working" elites. People were just told very often, what they are supposed to be obsessed about ;-]  
by das monde on Thu Aug 20th, 2009 at 08:21:35 AM EST
[ Parent ]
Killer bees! :O

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Aug 20th, 2009 at 03:14:14 PM EST
[ Parent ]


Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Aug 20th, 2009 at 03:13:03 PM EST
[ Parent ]
It became too hard to beat Goldman Sachs and hedge funds...
by das monde on Thu Aug 20th, 2009 at 10:48:21 PM EST
[ Parent ]
the survivor bias of the DJIA... comapnies that get weaker are dropped out before they collapse fully, and are replaced by the healthiest companies around.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Aug 20th, 2009 at 05:32:44 PM EST
[ Parent ]
That is true of capitalization-weighted indices such as the FTSE 100 and the S&P 500 as well. When a declining company drops below the top 100 or 500 or whatever it is replaced by an up-and-coming company.

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Thu Aug 20th, 2009 at 05:36:50 PM EST
[ Parent ]
I did the same graphs of SP500 as well. I don't see much difference:

The same sharp accelerations at around 1982 and 1994 are discernible. Only the 2007 peak looks less ridiculous.

Here is the logarithmic plot:

by das monde on Fri Aug 21st, 2009 at 12:03:07 AM EST
[ Parent ]
Could plot both series on the same log chart?

Anyway, looking at that S&P series I can't help but marvel at the succession of bubbles from 1950 to 1975, and I am reminded of my

Big bubbles have little bubbles
which feed on their liquidity
and little bubbles have lesser bubbles
and so on to volatility.
And the greater bubbles have themselves
even greater bubbles to ride on;
while these again have greater still
and greater still, 'till meltdown.


En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Fri Aug 21st, 2009 at 02:12:28 AM EST
[ Parent ]
Nice poem!

You should make a song borrowing the music from Pete Seeger's "Little Boxes":



"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet

by Melanchthon on Fri Aug 21st, 2009 at 03:09:36 AM EST
[ Parent ]
Here are both index series in the logarithmic plot. I multiplied the SP500 values by 4.4 to bring the graphs closer.

The graphs are pretty parallel. SP grew even faster before 1987.

by das monde on Fri Aug 21st, 2009 at 04:01:36 AM EST
[ Parent ]
Yes, I think this nails the coffin of the DJIA actually: the US economy was really growing 1960-1975. The S&P picked up this growth, not the DJIA. Around 1980, we had two parallel effects: a secular boom in equities that boosted the S&P, and also the beginning of "management" of DJIA so that it performs at least as well as S&P.

Post dot-com crash, the engineering becomes blatant: DJIA hung near flat when S&P crashed (they both had a dip on 9/11 though, you can't rebalance the index faster than airplanes crashing). And when S&P picked up, it just returned to dot-com bubble level. DJIA actually went higher !

Pierre

by Pierre on Fri Aug 21st, 2009 at 04:56:22 AM EST
[ Parent ]
Does this mean that the 1960s were not fantastic times for the biggest multinational companies, but rather good democratic times for mid-size companies? How much does the 1990s growth reflect the increased participation of pension funds? If large institutional investors tend to bet on "super" super-companies of the DJIA list, that may explain its "better" peak performance.

In this crisis, many people need more money, but a lot of money are wondering without a purpose. Somehow the financial system is not moving money from points A where it is to points B where it is needed (contrary to what one Rothschild likes to say). Instead, aimless money is making problems of its own.

by das monde on Mon Aug 24th, 2009 at 07:04:16 AM EST
[ Parent ]
It only means that the components were not updated enough in this period:

http://en.wikipedia.org/wiki/Historical_components_of_the_Dow_Jones_Industrial_Average

Updates in 1939, 56, 59, 76: it sucks...
Then 3 updates in the 80's, 3 in the 90's
And of course, already 5 updates in this decades, and counting...

In the 80-90, all stocks were free-riding the secular trend of retirement funds going for a gambit. But in most cases, their target benchmark was very broad, at least S&P500 or Russell2000

Pierre

by Pierre on Mon Aug 24th, 2009 at 10:42:19 AM EST
[ Parent ]
Kolmogorov bubbles ?

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Sat Aug 22nd, 2009 at 05:52:27 PM EST
[ Parent ]
Kolmogorov bubbles
Eh? Chto eto takoe?

--
$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Wed Sep 2nd, 2009 at 02:32:50 AM EST
[ Parent ]
Kolmogorov did some seminal work on the scaling properties of turbulent flow.

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Wed Sep 2nd, 2009 at 04:49:47 AM EST
[ Parent ]
One can only guess how much fun he'd have had in the world of financial mathematics... but that field was a bit beyond what he was allowed to dabble in.

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Wed Sep 2nd, 2009 at 09:59:30 AM EST
[ Parent ]
Shiryaev is a good example of what may be expected, though...

--
$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Wed Sep 2nd, 2009 at 07:34:14 PM EST
[ Parent ]
bubbles don't melt down, they burst...  they require a lot of surface tension to remain stable, and failure is invariably catastrophic

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Sep 1st, 2009 at 07:53:30 AM EST
[ Parent ]
das monde:
I don't see much difference
Now, now, doing things by eye doesn't cut it.

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Fri Aug 21st, 2009 at 03:42:43 AM EST
[ Parent ]
:-) A telescope in offer?
by das monde on Fri Aug 21st, 2009 at 04:08:01 AM EST
[ Parent ]
(Lagged) cross-correlation?

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Fri Aug 21st, 2009 at 04:19:52 AM EST
[ Parent ]
NewScientist.com:

... a team of physicists and financiers [successfully predicted] a steep fall in the Shanghai Stock Exchange.

Their model, which employs concepts from the physics of complex atomic systems, was developed by Didier Sornette of the Financial Crisis Observatory in Zurich, Switzerland, and Wei-Xing Zhou of the East China University of Science and Technology in Shanghai. The idea is that if a plot of the logarithm of the market's value over time deviates upwards from a straight line, it's a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies. By projecting the trend, the team can predict when growth will become unsustainable and the market will crash.

Sornette, Zhou and colleagues applied their model to the Shanghai Composite Index, which tracks the combined worth of all companies listed on the Shanghai Stock Exchange, the world's second largest. Early this year, the index gained 50 per cent in just four months. In July, the team predicted that the index would start to fall sharply by 10 August (www.arxiv.org/abs/0907.1827). The index duly began to slide on 4 August, falling almost 20 per cent in the subsequent two weeks.

Now "everyone" is predicting even more.

Shanghai Index May Drop 25% on Economy - Bloomberg.com

The Shanghai Composite Index, the world's worst performer in August, may fall another 25 percent as China's economic recovery isn't "sustainable," former Morgan Stanley Asian economist Andy Xie said.

The measure plunged 6.7 percent to 2,667.75 yesterday, the most since June 2008, and entered a bear market on concern a slower lending growth may derail a rebound in the world's third- largest economy. Xie said the index "should be 2000 or less." The gauge rose 0.6 percent to 2,683.72 today.

"The market is in deep bubble territory," Xie, 49, who correctly predicted in April 2007 that China's equities would tumble, said in an interview with Bloomberg Television.

by das monde on Wed Sep 2nd, 2009 at 10:28:15 PM EST
[ Parent ]
So basically they're saying that exponential growth is the norm for stock markets.

They're in for a rude shock in the 21st century...

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Sep 3rd, 2009 at 08:27:43 AM EST
[ Parent ]
das monde:
The idea is that if a plot of the logarithm of the market's value over time deviates upwards from a straight line, it's a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies.
And you need a "team of physicists and financiers" for this?

They have to be doing something more than just that if das monde:

In July, the team predicted that the index would start to fall sharply by 10 August (www.arxiv.org/abs/0907.1827). The index duly began to slide on 4 August, falling almost 20 per cent in the subsequent two weeks.


En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Thu Sep 3rd, 2009 at 08:59:00 AM EST
[ Parent ]
I have thought the Dow was overvalued since it hit 1200 in the early 80's.

In my opinion current fair value about 3000 - 4000.

But what do I know ?

by acurmudgeon on Tue Sep 1st, 2009 at 03:07:46 PM EST
Welcome to ET, acurmudgeon!

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman
by dvx (dvx.clt ät gmail dotcom) on Wed Sep 2nd, 2009 at 04:39:56 PM EST
[ Parent ]
Precisely my own thoughts.  My other response to this diary is to remember that the Dow Jones is NOT the economy, and less so now than before.
by Andhakari on Fri Sep 4th, 2009 at 01:28:54 AM EST
[ Parent ]
Just follow the Dow.

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Fri Sep 4th, 2009 at 03:42:39 AM EST
[ Parent ]
One cannot infer causality from correlation.  My brother made a lot of money for a while by speculating in commodity futures basing his predictions on Fibonacci ratios.  Needless to say, he's just another aging working smuck now.
When price / earnings ratios ceased to be as important in financial predictions and investment decision making as the occult and magical mathematics, the stock market took on magical properties as well.
Now we may get to see it behave like a rabbit in a magician's hat.
by Andhakari on Fri Sep 4th, 2009 at 05:16:19 AM EST
[ Parent ]


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