Dow Index Giving a Distorted View of '05

By Tom Petruno

Dec. 15, 2005 12 AM PT

Times Staff Writer

With about two weeks to go this year, the Dow Jones industrial average is painting a dreary picture of Wall Street’s performance in 2005.

But as in 2004, the best-known stock index is telling a fib, of sorts: The market is doing a lot better than the Dow suggests.

To some investment pros, the Dow’s continuing misery is an invitation to pick up what they believe are tremendous bargains in the blue-chip bin.

The 30-stock Dow index, which consists of some of the nation’s biggest companies -- General Electric Co., Wal-Mart Stores Inc. and Boeing Co. among them -- rose 59.79 points, or 0.6%, to 10,883.51 on Wednesday. That lifted its year-to-date price gain to a measly 0.9%.

That is the worst performance of any major market gauge. By contrast, the Standard & Poor’s 500 index, which gained 5.31 points, or 0.4%, to a 4 1/2 -year high of 1,272.74 on Wednesday, is up 5% this year.

Many indexes that track stocks of smaller companies are doing far better than the Dow or the S&P; 500. An S&P; barometer of small stocks, for example, has surged nearly 10% this year.

Even including dividend income, the Dow’s year-to-date return is just 3.2%.

The Dow’s woes in part reflect the disdain many investors have shown in this decade for big-name companies in general -- a complete turnabout from how the stocks were perceived in the 1990s.

The reversal of fortune for blue chips “is one more example of how the market takes things to extremes,” said Michael Holland, head of money manager Holland & Co. in New York.

For much of the ‘90s, blue-chip shares ruled on Wall Street. By 2000, investors’ hunger for the stocks had pushed many of them to extraordinary heights relative to underlying earnings.

When the bear market began in 2000, the highest fliers in the Dow began to crumble.

More striking has been that, since the new bull market was born late in 2002, the Dow has seriously lagged the gains in most broader share indexes.

One issue for the Dow is that some of its companies have faced particularly vexing problems in recent years. Shares of General Motors, for example, plunged 25% in 2004 and are down 44% this year as high energy prices have slammed car sales.

Although GM is just one of 30 stocks in the index, a decline of 44% in one year “isn’t going to help matters,” said Phil Orlando, a portfolio manager at Federated Investors Inc. in New York.

Pfizer Inc. and Merck & Co., two drug giants in the index, have been hammered by dimmed growth prospects amid rising competition from generic drugs. Pfizer is down 15% this year; Merck is off 9%.

Some experts also see the Dow as a victim of bad timing: Dow Jones & Co., which decides which stocks go into the 109-year-old index, added technology leaders Intel Corp. and Microsoft Corp. to the club in October 1999 -- shortly before Wall Street’s tech mania peaked.

Intel stock still is 35% below its level at the end of 1999; Microsoft is down 54% since then.

More broadly, the challenge for the Dow stocks has been that many investors simply have become much more enamored of smaller companies. As the economy has expanded since 2001 many smaller firms have posted earnings growth that has far exceeded that of mature Dow members such as Coca-Cola Co. and IBM Corp.

And because smaller stocks had been deeply out of favor in the late 1990s, there has been a certain amount of catch-up in their recent performance, analysts say.

The longer the Dow continues to drag behind, however, the greater the appeal of the stocks for bargain-hunters, some veteran investors contend.

By one common measure of value -- price-to-earnings ratios -- large stocks appear far less expensive than smaller stocks.

The average big-name stock now is priced at about 17 times estimated 2006 earnings per share, according to Bloomberg News data. By contrast, the Russell 2,000 small-stock index is priced at about 28 times estimated 2006 results.

“Clearly there is a valuation disparity,” said Orlando, who owns blue chips including GE, IBM and Johnson & Johnson in mutual funds he manages.

Like many big-stock fans, Orlando believes that the key catalyst for a rebound in the shares would be a slowdown in the economy, which he expects in 2006.

“Typically when the economy slows, investors shift their focus from small- and mid-cap stocks to large-cap stocks,” he said. In part, that’s because a slowdown poses greater risk of earnings disappointments for fast-growing companies. In addition, because many bigger companies are financially robust and have global reach, they’re viewed as less risky overall than smaller firms, Orlando noted.

Still, talk of a comeback for big-name stocks has been rampant on Wall Street for two years, yet the Dow remains depressed.

That doesn’t distress Holland, who owns Dow issues including Microsoft and Pfizer.

“It’s only a matter of when, not a matter of if for these stocks,” he said.

Among the market’s highlights on Wednesday:

* Winners topped losers by 3 to 2 on the New York Stock Exchange, as investors were encouraged by a drop in Treasury bond yields one day after the Federal Reserve hinted that it may be nearing the end of its credit-tightening campaign.

The 10-year Treasury note yield fell to 4.46% from 4.52% on Tuesday.

* The Nasdaq market was relatively weak. The Nasdaq composite index lost 2.41 points, or 0.1%, to 2,262.59, hurt in part by a slump in Apple Computer, which slid $2.97 to $72.01 after hitting a record high Tuesday.

* The S&P; mid-cap and S&P; small-cap indexes both hit record highs, rising 0.4% each, as the advance in those market sectors continued. The NYSE composite index also hit another new high, rising 0.4%.

* In commodity trading, gold futures sank for a second day as profit takers swarmed after the metal reached 24-year highs on Monday. Gold dropped $14.50 to $506.50 an ounce in New York.

Crude oil futures eased 52 cents to $60.85 a barrel.

(BEGIN TEXT OF INFOBOX)

Blue-chip blues

The 30-stock Dow Jones industrial average has badly lagged behind the broader market for the last two years.

Price changes of key indexes

2005

Dow: +0.9%

S&P; 500: +5.0

S&P; small stocks: +9.9

2004

Dow: +3.2

S&P; 500: +9.0