Indices in the second decade of the 2000s are starting to look like bungee jumps. They’re also very neurotic, easily spooked, and very irritating things to work with. The high levels of insularity in the financial markets, where the real world apparently has to make an appointment to get a mention, aren’t helping much either. The markets are like power supplies. An electrician who’s current with the state of the systems knows exactly what’s going on.
How not to read indices
There are macro financial factors in all indices, but they’re dynamics, not climate indicators. Pressure is placed on markets by two factors: Loss and gain. Everything else is largely cosmetic. The oil price doesn’t really spike because a pipe in Nigeria blows up. It spikes because US supplies need more, and traders recognize the demand factors.
If you were using indices as predictors, you’d rarely get anything right. The macro and sector indices are actually more like water level readings for liquidity in a market. The tide comes in and goes out. A big spike means more often than not a sharp drop, because investors take their money and retire with a profit. A meandering index means traders buying and selling, and reflects margins more than economic or trade factors.
The big drops, typically, come from factors outside the indices. The 2008- 2009 free fall was caused by the financial sector impacting all the other sectors. The financial indices rattled along happily right until they went over the cliff. Huge amounts of capital were pulled out of the markets.
As barometers, indices are local weather only. They aren’t structured to tell you about the hurricanes on the way. Remember to keep an eye on the big picture. A look out the window will tell you more about the weather than a spreadsheet.
Using the indices
The indices do have a very practical range of uses for investors:
Industry and sector indices are reliable trading measures: If you want to see what’s hot, the indices will definitely tell you where the money’s going on the markets.
They’re useful performance indicators: Ironically, Exchange Traded Funds, which are based on mixes of stocks in specific indices, are very good measures of real performance. If you’re looking for a portfolio monitor, ETFs are perfect. Just watch the ETFs, and you’ll see the actual performance of a weighted portfolio.
The ETFs are working models of indices in real time. That’s a far more reliable way of pinning down performance. In ETF performance, the higher weighted stocks move the value of the ETF units up and down, exactly like a macro index, but much more accurately and they’re much easier to follow. You can do much better quality judgment, and be far less impressed with statements which try to pass off punch drunk “big rises” off very low bases, which are almost meaningless.
If you want to read indices, read performance first, then macro indices. To use the electrical analogy again, if you want electrical services, find the specialists in your field, not the gossip columnists.
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