How to Look at the Dow

March 24, 2009

I had a brief discussion with Jesse Eisinger yesterday about the stock market reaction to the Geithner plan. The central question: do you look at the level of the index, or do you look at the amount that it moved over the course of the day? Geithner’s first attempt at introducing the plan resulted in the Dow falling 382 points to 7,889; Geithner’s second attempt saw a 497-point rise to 7,776.

If you ignore the direction and just focus on the Dow as a snapshot of how the market feels about the prospects for the economy, you could make a case for investors being more optimistic the first time round than than they were yesterday. That’s true even if you look at a sensible index like the S&P 500, which closed yesterday at 823, down a smidgen from its February 10 close of 827, rather than looking at the silly but ubiquitous Dow average.

There are good reasons to look at the day-to-day movements. If the stock market simply priced in this public-private buy-up-the-toxic-assets plan on February 10, it wouldn’t have rallied so much on February 23. But the technicals matter too: yesterday’s rally had more than a whiff of short-covering to it, while in hindsight the fall on February 10 is barely noticeable when looked at in the context of the massive drop between September and March.

In general, I think it’s ill-advised to use day-to-day movements in the stock market as much of a barometer of anything; and if you are going to look to the Dow in order to gauge market sentiment, make sure to round it off to the nearest thousand points first. Anything more than that will give you a false impression of specificity. All the same, by that criterion we managed to rise from 7,000 to 8,000 yesterday. Which is worth at least a little smile.

Update: Yves Smith makes the very good point that although stocks rose sharply, there was little movement in the bond market, which tends to be a much better barometer of such things.

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