Saddam statue falls in Baghdad: Collect 60 Dow Jones Industrial points. Capture Qusay and Uday: Advance 200 points. Weapons of mass destruction found stored in Mosul junior-high-school lockers: Pick up 40 nasdaq points. Saddam Hussein found dead: Pass Dow 9,000 and collect 200 points. Friendly fire kills four soldiers: Retreat 100 points. Bin Laden captured: Go directly to Dow 10,000; do not stop at 9,500.
This surreal Parker Brothers–esque game is what passes for the stock market these days. Or at least it seems so to the traders who now dominate the day-to-day action. Anyone who watched the Dow rocket 60 points while the noose tightened on the Baghdad Saddam statue, only to see the bellwether average cascade as soon as Iraqi shoes started striking Hussein’s twisted and broken bronze head, knows that this market is being held totally hostage by world events.
But the linkage you see now doesn’t really make sense. In fact, the peaks and valleys stemming from world events will prove to be false tells. They will turn out to be wrong moves. Here’s why: Traders, and only traders, have been forcing these moves, gaming every single world event. They want the SPX, the DIA, and the QQQ—proxies for the S&P 500, Dow Jones, and nasdaq 100, respectively—to react mechanically to every yard of territory gained. They would rather trade the indices themselves than trade individual stocks, regarding the proxies as more “efficient” methods of investment because of their liquidity and their quick moves.
Yet the traders are missing the much bigger picture, something that you, if you’re playing the home version of this game, shouldn’t be fooled by. While the traders try to relate the minutiae of battle to Dow and S&P points, you should be relating the surge in consumer confidence and the decline in oil to higher prices for some, but not all, individual stocks. While traders are blinded by the liquidity of the Diamonds, Spyders, and Cubes (the shorthand for each proxy), you should be swooping in and buying the stocks of solid American companies that have been down on their luck because of the fears of a prolonged war that didn’t happen.
In other words, the traders are looking for gains in all the wrong places. There’s tons of money to be made in some stocks, even as the overall indices fail to react to each crashing statue or looted palace, because other stocks in those indices are faltering.
Before the advent of futures on stocks in the eighties, both professionals and amateurs bought stocks of companies whose prospects might be bright. But after the Chicago grain- and beef-futures types figured out how to create stock futures, some sophisticated managers began to use the S&P 500 future—the bedrock contract—as a hedging device. Too long a lot of good stocks? Lay off some risk by selling a future on the index.
In the nineties, the New York–based exchanges struck back at the Chicago stock grab and began offering stocks that mirrored the futures themselves. Most managers were scared to use futures or didn’t have the charters to use them. But when the exchanges rolled out these proxy stocks—the Spyders, Diamonds, and QQQs—they became instant favorites of everyone from unsophisticated mutual-fund hands to incredibly nimble hedge-fund managers.
These days, of course, money runners seem more enamored of the indices themselves than the stocks that make them up. They want the simplicity of roulette: Red means sell Spyders, QQQs, and Diamonds; black means buy them. Managers now reach for DIAs on any good war news and sell DIAs on anything that smacks of terror, no matter how knee-jerk. It’s become an obsession for many money managers—trying to call every intra-day set of points in either direction by using these instruments.
Personally, I’d rather be gaming raindrops running down a windshield. The notion that you can try to figure out whether the market has ramped too much on the fall of Tikrit, or fallen too much on a possible terrorist-inspired fire on Staten Island, is simply too unfathomable. It’s just unmitigated gambling—not investing at all.
Which is why I am beginning to like individual stocks again. Stocks of companies that got clocked because the consumer was so worried about a long war—particularly big banks like Wells Fargo, Bank of America, and J.P. Morgan, and retailers like Lowe’s and Home Depot—are beginning to roar, even as the indices seem to be doing nothing.
What should you be doing? For starters, recognize that the stunning military victory is indeed worth some points to some stocks and nothing to others. I don’t think, for example, that tech gets helped one iota by the end of the war. Neither does telecom.
But Viacom? Here’s a company that was directly impacted in terms of a dramatic pause in ad revenue. That’s past; earnings estimates can go higher. Or May Department Stores? It, along with Wal-Mart and Target, was hurt by the CNN Effect: people staying home to watch the war. That’s history; I expect numbers to improve now. These stocks performed fabulously after Gulf War I, rebounding from a similar interruption; why should this time be different?
But the indices? Be careful. You might be buying some of the good stocks, but more likely you are purchasing plenty of Intel, Cisco, Microsoft, IBM, SBC Communications, Verizon, and other large capitalization stocks that don’t stand to gain at all from the war’s cessation.
Tons of individual stocks remain cheap these days. But a like number, particularly in tech and telecom, remain far too expensive. The only way to be sure you aren’t playing in nosebleed territory is to game the traders themselves and avoid their proxies entirely. That’s the only way to ensure outperformance in a market that increasingly resembles the tables at the Bellagio or Trump Taj and not the capitalization of some great, and not-so-great, American companies.