Dow Futures

The Dow Jones (INDEX: ^DJI  ) is down 0.88%, or 115 points, in afternoon trading. The obvious culprit is the nonfarm payroll data from last week that showed only 120,000 jobs were added in March. That’s well below the increase of 203,000 that economists were expecting.

With markets tumbling on the back of the payroll data, should investors be overly concerned that the market is running out of steam? I wouldn’t say so. First off, in previous recoveries there have been periods where job growth dropped off for a brief period before resuming. As an example, the recovery that started in 1981 featured a heart-stopping job loss one month before resuming its upward trajectory.

Second, while the unemployment rate sits at 8.2%, the “underemployment rate” — which includes those who gave up looking for jobs and people who have taken part-time jobs instead of full-time ones — ticked down to 14.5% from 14.9% in February. That’s a huge drop, and shows that less-frequently-cited “shadow” economic measures showing job growth remained relatively stable even if the headline figure took a tumble for the month. Foolish colleague Morgan Housel further breaks down the figures in this great column looking deeper at the jobs report.

However, this all leads to a larger point: Unemployment alone doesn’t show the direction of the economy. We’re currently in a period where corporate earnings continue rebounding at a solid rate — a bit stronger than 6% year-over-year last quarter — in large part because companies have been successfully cutting costs. For better or worse, persistently high unemployment is being driven by lower-paying jobs that don’t always reflect the growth potential of the large global firms that make up the S&P 500 (INDEX: ^GSPC  ) .

With that in mind, the best course for investors this week is looking past the job report and ahead to Alcoa kicking off the earnings season this Tuesday. With corporate growth having seen a decoupling from trends like lower unemployment (in large part because of the aforementioned global footprint of most large S&P companies), earnings season will give a good look into whether the recovery is still on course.

Banking is getting hit hard today, with Bank of America (NYSE: BAC  ) seeing the largest drop of all Dow components, and the financial sector as a whole down 1.3%. On Friday we’ll get a feel for the overall health of the financials when JPMorgan Chase (NYSE: JPM  ) , a company which managed the financial crisis better than its peers, steps up to the earnings plate. The company is expected to post adjusted earnings of $1.15 per share, which is still below last year’s posting of $1.28. More indicative of the overall continuing health of the recovery might be Google‘s (Nasdaq: GOOG  ) report on Thursday. Information technology has led the market rally and Google is expected to post earnings of $9.64 per share versus $8.08 last year. After badly missing earnings last quarter, Google has been one of the few large tech companies that hasn’t seen its shares soar this year.

So if you’re looking at the health of the recovery, look past the jobs data. With earnings season just around the corner, there’s bigger fish to fry.

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Ah, to remember the heady days when Bernanke’s off-the-cuff remarks set Wall Street ablaze and led the Dow Jones (INDEX: ^DJI  ) on another rally. Yes, if you remember back to those golden days, which were all but a week ago, Bernanke had hinted that “supportive policies” from the Fed would continue.

However, while Bernanke has long been more of an activist in his approach to stimulating the economy, it’s also been known that other Fed presidents weren’t sold on the idea of more stimulus. Minutes released today from the last Federal Market Open Committee, or FOMC, show a wide range of opinions and a distinct lack of consensus with Bernanke.

The long and short of the situation: There is no consensus among Fed presidents on easing, and additional stimulus won’t be pumped into the system unless the economy unexpectedly falters. The Dow reacted by falling on the news and is currently down 0.07% in late trading. Contrarily, the yield on 10-year Treasury Notes (INDEX: ^TNX  ) soared immediately on release of the minutes.

The long-term picture
While markets in the United States might be dropping on the FOMC minutes, the bigger picture is that the Fed is going to take stimulating actions if the economy falters. Even with today’s drop, the market has still been on an absolute tear recently, with the Nasdaq (INDEX: ^IXIC  ) posting its best first quarter since 1991. I wouldn’t be overly concerned with today’s FOMC minutes, and I point to the fact that while the market might cheer a longer timeframe of next-to-zero interest rates in the short-term, too loose of a policy would be bad for investors in the long term.

On the bond front, it has long been known that buying bonds at today’s low yields to maturity is a dicey endeavor. If you’re holding long-term bonds, which will drop in price if interest rates soar, then the Fed’s minutes are definitely an ominous sign that there could be two ways for your investment to drop: an economic recovery or a lack of consensus in the Fed leading to less stimulus and holding down current rates.

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While reading Josh Brown’s book Backstage Wall Street this weekend, I came across this quote from current New York Times columnist Joe Nocera. It’s from 1995, when the Dow Jones (INDEX: ^DJI  ) traded at around 4,000. Back then, Nocera couldn’t believe the optimism sweeping investors away:

The pessimists — PESSIMISTS! — say that the Dow will go to 5000 by the turn of the century, and that the fund industry will grow by an additional trillion dollars. The most optimistic — Jessica Bibliowicz of Smith Barney, as it happens — predicts a 6500 Dow.

Funny: By 2000, the Dow traded above 11,000. How many times in history have the most optimistic investors been off by 70% on the upside? As far as I know, never.

I won’t ramble on about how big the dot-com bubble was or how dumb investors were back then. That got old years ago.                

But there’s a related point that’s still worth talking about. What’s interesting about the 1995 forecasts Nocera cites is how rational they were. Since the 1950s, the Dow has increased by an average of 6.8% a year (before dividends). With the Dow trading at 4,000 in 1995, the analysts polled in Nocera’s article were forecasting annual returns of 5% to 9% — normal, average returns, basically.

In other words, assuming valuations were reasonable in 1995 (and they were, for the most part), the Dow should have traded somewhere between 5,000 and 6,500 in 2000. That’s where you should have expected it to have been had there been no dot-com bubble.

Now, if the Dow had traded at 5,000-6,500 in 2000, think about what that would mean for investors today. Instead of the “lost decade” investors endured from 2000-2010, they would have earned an average annual return of 6% to 8.5% a year — almost exactly average, historically.

Here’s another way to think about this. The light line below is a hypothetical Dow increasing 6.8% a year (the historic average) starting in 1995. The dark line is the actual Dow:

Sources: S&P Capital IQ and author’s calculations.

Did you notice? The two lines end in the exact same spot. Returns from 1995 through today have been almost exactly average, historically.

And yet think of all the frustration over lousy market returns lately — disgruntled investors sullen over the fact that most money invested over the last decade has lost value after inflation. Without question, the last 10 or 12 years have been an awful time for most investors.

The takeaway from that is really important:

• From 1995 through today, the Dow produced average returns of about 7% a year. That’s good.
• But nearly all of those returns happened from 1995 to 2000. The market literally took 17 years’ worth of returns and squeezed them into five, which sent valuations in 2000 through the roof.
• Valuations in 2000 practically guaranteed that returns over the last decade would be poor.

I know. You might think it’s Monday morning quarterbacking for me to say, “Look, if you invested in 1995 instead of 2000, you’d be rich today!”

But that’s exactly what I’m saying, and I think it needs to be repeated over and over again. For the literally tens of millions of pages of market analysis and financial advice out there, smart investing really boils down to just three points:

• Buy stocks when they’re cheap, or at least reasonably valued. That doesn’t mean market timing; it means focusing on valuations above all else.
• Hold them for a long time. That could mean a decade or more.
• Ignore what happens in between. If you choose to watch, be assured: It will be ugly at times.

Anyone who bought from 1997-2000 or 2006-2007 when valuations were high and felt cheated two or three years later as returns sank broke all three rules. Many more will do so in the future. And just like over the last decade, they’ll sit in shocked disbelief, wondering what happened, when the honest answer is, “Nothing unusual.”

As Ben Graham, Warren Buffett’s early mentor, used to say, “In the short term, stocks are a voting machine, and in the long term, stocks are a weighing machine.”

During no time has that been more evident than 1995 through today.

Shortly after 2 p.m. EDT, the Dow Jones (INDEX: ^DJI  ) had settled into a loss of 0.40% after opening the morning down sharply. Shortly after the open, the Dow had slumped 0.88% before rebounding across the day. That’s a decent drop, but it pales in comparison to the 1.17% drop seen in Europe’s FTSE 100 (INDEX: ^FTSE  ) .

So what’s causing world indexes to drop today? There are two major comments surrounding China and its growth that seem to be primary culprits. BHP Billiton‘s president of iron ore commented that steel growth rates are flattening. Another reason for hand-wringing is that an official from the China Association of Automobile Manufacturers predicted auto sales growth will miss an 8% target, and could be even lower than 5%.

BHP’s warning doesn’t come as a huge surprise. It’s long been known that China was trying to slow its overheated building boom to focus more on consumer spending as a means of driving GDP. A large slowdown in Chinese demand has already been priced into BHP and its peers, who have seen steep drops in their share price across the past year. The auto news is a little more disconcerting since it deals with lower spending from the consumers who are supposed to be picking up China’s economic slack. The news pushed auto stocks particularly low at the market’s open. General Motors (NYSE: GM  ) slumped 3.1% shortly after the markets opened while Ford (NYSE: F  ) slipped 1.9%. As the day has progressed, both stocks have bounced back.

In the long run, I think you’d have to be crazy to think China would travel on an unvarnished economic path to becoming the world’s largest economy. Of course there will be some bumps in the road. The question is whether China can successfully navigate its property bubble problems while shifting more of its economic output to consumer spending. On days like today, it might feel like the answer is no. However, looking past the fear in the market over China today, the long-term opportunity remains in place.

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We’ve all heard about having a case of the Mondays, but it looks like the Dow Jones (INDEX: ^DJI  ) is taking the day off and watching some March Madness. Shortly before 2 p.m., the index sits down just 0.5, essentially a rounding error to being flat. The Dow had opened higher after Europe’s FTSE 100 (INDEX: ^FTSE  ) ended the day up 0.42% on the end of banking gains.

That’s not to say today isn’t an active market day. Volume is heavy for a number of Dow stocks. Like its banking brethren in Europe, Bank of America (NYSE: BAC  ) is taking off. The company has already handily passed its average trading volume for the day and is up 3.9% despite little news on the day. The cause of Bank of America’s gain today is likely linked to the afterglow of the company’s passing the latest round of stress tests. In total, Bank of America is up 19.5% this week and has notched a 75% gain this year.

In spite of the market’s malaise today, the overriding story is that in the week stocks continued their upward gain. The S&P 500 (INDEX: ^GSPC  ) is up about 2.4% on the week, led by — you guessed it! — the banking sector. The S&P Bank ETF (NYSE: KBE  ) was up 7.8% this week. In the fourth quarter, banking stocks posted only 3.6% year-over-year growth in earnings, a far cry from technology’s earnings growth of 17.1% or energy’s 13.4% leap. However, many top banking stocks were punished last year, so signs of an improving economy and stress test results that were better than expected have brought investors back into the space.

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Some celebrated the Dow Jones (INDEX: ^DJI  ) finally closing above 13,000 yesterday, but another more-meaningful milestone was recently reached. Adjusted for dividends, the Dow is at an all-time high, surpassing its nominal record set in October 2007:

Source: S&P Capital IQ, using dividend-adjusted returns of SPDR Dow Jones Industrial ETF.

What does this mean? Like Dow 13,000, not much. It’s a psychological milestone that tells us nothing about value, opportunity, or what might happen next.

But what it does say loud and clear: Patient investors win. After the deepest recession since the Great Depression and a near collapse of the global financial system, it took just four years for investors who bought at the very top to recoup their losses. Those who scooped up bargains along the way have done far better.

How have you done over the past four years?

Some celebrated the Dow Jones (INDEX: ^DJI  ) finally closing above 13,000 yesterday, but another more-meaningful milestone was recently reached. Adjusted for dividends, the Dow is at an all-time high, surpassing its nominal record set in October 2007:

Source: S&P Capital IQ, using dividend-adjusted returns of SPDR Dow Jones Industrial ETF.

What does this mean? Like Dow 13,000, not much. It’s a psychological milestone that tells us nothing about value, opportunity, or what might happen next.

But what it does say loud and clear: Patient investors win. After the deepest recession since the Great Depression and a near collapse of the global financial system, it took just four years for investors who bought at the very top to recoup their losses. Those who scooped up bargains along the way have done far better.

How have you done over the past four years?