Letter to a 6th Grader

Recently (March 2016) a 6th grader contacted us regarding a school project.  I felt his questions were quite sophisticated for a 6th grader, and below are my answers, which you might find of interest:

  1. What is the Dow Theory?
    Charles Dow was the co-founder of the Wall Street Journal in the 1880s, and it was his theory, related to the stock market, that when shares of Industrial companies and Transportation companies were doing well in the stock market that was an indication that the economy was doing well.  His logic was that the Industrials produced goods and the Transports delivered them, each dependent on the other, and if they were both doing well then so too was the economy.  Of course, if both, or neither, were doing well then the economy was on shaky ground.
  2. What are key points on predicting stock market?
    The outlook for the stock market is dependent on many things, not the least of which is the outlook for the success of its many companies. Earnings increases drive increasing stock prices and the overall economy is important to companies success.  But as with anything, prices of a good thing can get too far away from value, in which case the outlook for further gains are diminished.  Therefore the price to earnings ratio is a good guide, based on historical norms, as to the future outlook for stocks and hence, the stock market as a whole.
  1. Is predicting stock market hard/complex or relatively simple?Please explain...
    As explained in simple terms (above), there are numerous inputs to the stock market's outlook. Individual companies face competition, personnel changes, weather disruptions, labor problems, and a myriad of other influences, hence predicting is not easy, it is hard/complex.
  1. What do you think of the economy these days? Is it stable or becoming unstable? Please explain...
    The economy today has been progressing at a minimally acceptable rate since the last recession.  Because it is so tentative/fragile, as opposed to strong and stable, it is susceptible to falling into another recession in the year or two ahead.  Recessions and economic expansions are facts of life in a free economy, so each can be counted on to come into play from time to time.
  1. Do you think that there will be a stock crash in the near future? Why do you think such...
    The short answer: No.  Stock market crashes are few and far between.  In addition, the definition is unclear.  Bear markets are defined by most as a 20% decline (although my own definition is a 16% decline on both the Dow Jones Industrials and the Standard & Poors 500 Index - for more on this see https://thedowtheory.com/resources/bull-bear/).  I am expecting a Bear market in the near future, but not a crash.
  1. What do you think of Capitalism?
    I totally believe in Capitalism where, according to this simple definition, "an economic and political system in which a country's trade and industry are controlled by private owners for profit, rather than by the state".
  1. More and more people are being replaced with computer algorithm to predict stock market. Do you think people can beat machine? Please explain...
    IF the machine is properly programmed to cover all contingencies then the machine wins. That's a big 'if' as 'all contingencies' are not predictable. Human input is required but the downside is that emotions and preconceived prejudices come into play.  It is the rare individual who has the capacity to act rationally in all circumstances, hence it is tough for people to beat either the machine or the stock market.
  1. What do you think is the most important thing in keeping a stable stock market?  Please explain...
    As J.P. Morgan (a famous successful investor from the 1930s) once said "Stocks tend to fluctuate", in other words they are volatile. Such volatility keeps the stock market from being 'steady as she goes'.  I'm afraid a 'stable stock market' it an oxymoron, not ever attainable.
  1. If you were just beginning your professional life as a stockbroker how/where where would you locate your funds?
    I would go slow, there is so-o-o much to learn as a new stockbroker.  Unfortunately, young stockbrokers often make the mistake of taking risks in their personal accounts that they would not think of recommending to their clients (unfortunate in the first instance, fortunate in the latter).  It is that aggressiveness that is their downfall, and I've seen it many times!  Patience is something that many/most new stockbrokers do not possess, nonetheless that is what I would council.  Diversify your portfolio in quality names and speculate with a minor portion only where you personally know something of what you are buying.   And don't be too quick to sell and 'grab the profit'.  They say you can't go wrong taking a profit, but you can sell too early when you have a good thing going your way.

And finally

  1. What is your favorite part of your job?  Please explain...
    I am a long-since retired stockbroker.  I am still an active investor and stock market Letter writer as you must know. Therefore, I'll answer your question in that vain.  Successful investing is very fulfilling, sometimes from seeing the companies you invest in do well for others with useful products, and more specifically when your investement results allow you to live the life you choose.  It is most rewarding to hear from Subscribers to my investment Letter or from readers of my book, that they have been able to put their kids through college and/or retire early and successfully because of the guidance and understanding they derived from the Subscription or the book.  And I enjoy passing on some of the lessons I have learned to new investors, or potential investors such as you, my new friend.

Best of luck to you in your project
Sincerely,
Jack Schannep
Editor
TheDowTheory.com



Latest News

Mark Hulbert of Marketwatch: The Transports have been the stronger of the two benchmarks, and it is widely considered to be a leading economic indicator.  Read the article HERE.

There has been renewed interest in the Dow Theory since Jack Schannep presented his research to the Market Technicians Association that showed Dow Theory produced an excess return of 1.5% per year (from 1953 thru 2011) versus a buy and hold strategy.  His presentation attracted a whole new generation of Dow Theory enthusiasts.   Read the article HERE.

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