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Watch for TARPs Part Three and Four

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More bailouts certainly in our future.

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What does it mean for Citigroup (C) to be at $3? As it turns out, it distorts the information we think we're getting from the Dow Jones Industrial Index. And more TARP money is surely in our future - far more than anyone in authority is now suggesting. This week's letter will cover both topics and a little more.

Mister Softee is Only Worth 136 Dow Points

Off and on over the years I've written about the distortions that the Dow Jones Industrials creates by using a price-based index rather than a market-cap index. As an example, if Microsoft (MSFT) with a market cap of $153 billion went to a price of 0, the Dow would lose only 136 points, or less than 2%. If International Business Machines (IBM) with a market cap of $120 billion went to 0, the Dow would lose over 700 points! But it gets worse.

Jim Bianco (www.biancoresearch.com) allowed me to reproduce this note for your edification - prices quoted below are from a few days ago:

"Comment - The Dow Jones Industrial Average (DJIA) is a price-weighted index. The divisor for the DJIA is 7.964782. That means that every $1 a DJIA stock loses, the index loses 7.96 points, regardless of the company's market capitalization.

Dow Jones, the keeper of the DJIA, has an unwritten rule that any DJIA stock that gets below $10 gets tossed out. As of last night's close (January 20), The DJIA had the following stocks less than $10...

Citigroup (C) = $2.80
General Motors (GM) = $3.50
Bank of America (BAC) = $5.10
Alcoa (AA) = $8.35

If all 4 of these stocks went to 0 on today's open, the DJIA would lose only 157.3 points.

"The financials in the DJIA are...

Citigroup (C) = $2.80
Bank of America (BAC) = $5.10
American Express (AXP) = 15.60
JP Morgan (JPM) = $18.09

If every financial stock in the DJIA went to 0 on today's open, it would only lose 331.25 points, less than it lost yesterday (332.13 points).

If you want to add General Electric (GE) into the financial sector, a debatable proposition, then: General Electric (GE) = $12.93

If the four financial stocks above and GE opened at 0 today, the DJIA would only lose 434.24 points.

The reason the DJIA is outperforming on the downside is the index committee is not doing it job and replacing sub-$10 stocks, and the financials are so beaten up that they cannot push the index much lower.

So what is driving the index? The highest-priced stocks:

International Business Machines (IBM) = $81.98
Exxon (XOM) = $76.29
Chevron (CHV) = $68.31
Proctor & Gamble (PG) = $57.34
McDonald's (MCD) = $57.07
Johnson & Johnson (JNJ) = $56.75
3M (MMM) = $53.92
Wal-Mart (WMT) = $50.56

For instance, if all the sub-$10 stocks listed above, all the financials listed above, and GE opened at 0, the DJIA loses 528.63 points. To repeat if C, BAC, GM, AA, JPM, AXP and GE all open at 0, the DJIA loses 528.63 points.

If IBM opens at 0, it loses 652.95 points [IBM has risen since then – JM]. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE, and Alcoa combined.

The DJIA is not normal as the index committee is not doing their job during this crisis, possibly because to the political fallout of kicking out a Citi or GM. As a result, this index is now severely distorted as it has a tiny weighting in financials and autos."

You could add Microsoft to the list Jim created and not be over where IBM is today in terms of the DJIA index.
No positions in stocks mentioned.

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