Breakout

Dow, S&P Tell Two Different Tales as 2011 Heads Toward a Close

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All market indices are not created equal. It may not be fair, but it's the way it is. Case in point: as 2011 hurtles toward its end, the Dow Jones Industrial Average (^DJI) is comfortably cruising towards a 5% finish, while the S&P 500 (^GSPC) is paddling ferociously in hopes of simply getting back to even.

"I think the same tug o' war that happened all year in the markets will happen over the next 5 days," says John Canally, Chief Financial Economist and Investment Strategist at LPL Financial. He thinks the S&P 500 will eventually be able to "eek out" a small win, pointing out that in a year full of bad news, simply breaking even for the year really isn't such a bad result.

Of course the problem behind this discrepancy, or index injustice, is simply methodology in as much as the Dow is a price weighted index but the S&P 500 is market cap-weighted. Thus, in the Dow, the higher your share price, the more influence you have over the underlying index, while in the S&P 500, the bigger you are, the bigger your punch.

The point of this diatribe is that the worst performing stocks in the Dow this year (Alcoa and Bank of America) also happen to have the lowest share prices. Therefore, their individual plight has a much smaller impact on the Dow as they would on the S&P.

For Canally, the main risk that could prompt a short-term stumble by the S&P would be a massive political blunder by Congress. Given the rancor over the payroll tax debate and the extension of unemployment benefits that still seems like a possibility.

"I think the best outcome for that would be that they do no harm and just go away and then come back next year and fix it," Canally says.

In the meantime, Canally states a preference for what he calls "domestically facing" companies, that don't have exposure to the ills of Europe or the uncertainty of China. In as much as retailers meet the domestic criteria, Canally says they bring with them a different risk; margin risk, brought on by aggressive pricing.

Is he right? Do you think we're in for a year end stumble or a sprint to the finish line?

Lets us know below or on Facebook or Twitter @MattNesto

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