Putting the Market's Drop in Perspective

Last Tuesday brought one of the biggest declines of 2010 and that always makes investors nervous. This Tuesday brought more of the same. Are these one or two-day events or the start of something more dramatic and prolonged? Thus far these two sessions don't appear to be anything out of the ordinary.
For some perspective we need to understand the Dow Jones Industrial Average. When Charles Dow developed this index over 100 years ago, he added up the prices of the stocks in the index and then divided by the number of companies; the result was an average of the price. Today, the Dow remains a price weighted index. Over the years, stocks rose in price and then split, this caused the divisor in the Dow to decline. Today, there have been enough splits in the Dow that the divisor has fallen below 1, to 0.132319125. In other words, the ‘divisor’ has now become a ‘multiplier’. Let’s look back at an example: the divisor was around 7 back in the late 1970’s. If every stock in the Dow gained $1 back then, it would have produced a move in the Dow of 4.29 points ($1 times 30 stocks, divided by 7). Today the move is far greater. The same 1 point move in each of the 30 Dow stocks results in the index moving 226.72 points. This is basically what we saw the past two Tuesdays. While a 200+ point decline is not a lot of fun, a little perspective can help. I don’t like to see huge declines in the market anymore than the next guy, but in the grand scheme of things these declines were not as significant as they first appear, or as the media makes it out to be...
Last Tuesday’s market drop caused my primary indicator, the NYSE Bullish Percent indicator (BPNYSE), to fall by 0.56. This Tuesday it dropped 1.42, this means that the indicator remains at 77.654%. To bring the defensive team onto the field it would need to drop to 74%. Normally it takes a number of days or even weeks to see the Bullish Percent reverse direction, up or down. There are exceptions, but those typically occur at market bottoms and not market tops, as bottoms tend to be far more volatile than tops. Lastly, before the Bullish Percent reverses down, we typically see a number of other indicators reverse and turn negative as a ‘heads up’ of sorts - I have not yet seen that either.
In summary, despite a ‘large’ decline in the DJIA last week and today, the indicators remain positive at this time.

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