Game Theory: Simon Sinek & Benjamin Graham Analysis of the Dow 30

FinTrust Brokerage Services | Equity Research

July, 2021

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Industry: Diversified

Tracking ETF: SPDR Dow Jones Industrial ETF (DIA)

Index Overview: The Dow Jones Industrial Average is a 30-stock, price-weighted index that measures the performance of some of the largest U.S. companies. The index provides suitable sector representation with the exception of the transportation industry group and utilities sector which are covered by the Dow Jones Transportation Average and the Dow Jones Utility Average respectively. When Charles H. Dow first unveiled his industrial stock average on May 26, 1896, the stock market was not highly regarded. Prudent investors bought bonds, which paid predictable amounts of interest and were backed by real machinery, factory buildings and other hard assets. Today, stocks are widely accepted as investment vehicles, even by conservative investors. The 30 stocks now in the Dow Jones Industrial Average are all major factors in their industries, and their stocks are widely held by individuals and institutional investors. Besides longevity, two other factors play a role in its widespread popularity: It is understandable to most people, and it reliably indicates the market’s basic trend. Sources:DJAverages.com and spindices.com

Analyst Notes:
Analysis by Allen Gillespie, CFA (864) 288-2849
Are Stocks Too High to Buy?
Game Theory: Bitcoin, Gold, Dow Theory, Defi, Simon Sinek & Benjamin Graham
Analysis of the Dow Jones Industrial Average

Nominal v. Real Prices

Investors should invest to increase or maintain the real purchasing power of their savings. In this effort, investors have traditionally used both technical and fundamental analysis tools like Dow Theory or a Benjamin Graham analysis of security values. Unfortunately, the oversized monetary printing presses and changing nature of the economy have turned many of these tools to rubbish. Our work, however, shows that these tools regain their value when one adjusts security values from nominal prices into real price equivalents and adjusts from controlled interest rates into free market equivalents.

The modern analyst faces difficulty estimating values due to the unprecedented degree of monetary deformation wrought by central banks and central planners. Central bank policies target nominal prices, prevent distressed selling, and created a monetary hall of mirrors for asset prices. Nominal prices have separated from fundamental values by what I term the “asset price inflation monetary gap.”

Global central banks and treasury departments actively lend at subsidized rates, and they buy both fixed income and equity securities with newly printed money on a near daily basis. As a result, the Bank of Japan and the Swiss Central Bank now rank among the Top 10 holders of a broad range of equity securities. For example, in its last 13-F filing the Swiss National Bank reported holding 65,603,396 shares of Apple, 27,893,417 shares of Microsoft, 11,038.366 shares of Johnson & Johnson, 10,559,848 shares of Proctor & Gamble, 7,225,294 shares of Visa, 10,559,848 shares of Proctor & Gamble, 3,792,538 shares of United Health Care, along with holdings in many other Dow Jones Index member securities. In the United States, Blackrock buys fixed income ETFs on behalf of the US Treasury with money supplied by the Fed through special purpose entities.

Continuous and indiscriminate central bank asset purchases distort financial markets because central banks are infinite players, whereas, individual investors have finite lives. Simon Sinek’s addresses the Game Theory quagmire that results when infinite players play against finite players in this Google talk:

Interestingly, however, with the development of cryptocurrencies, Defi, and tokeneconomics, the free market may have reversed the role and turned Central Banks into finite players.

Historically, nominal to real price adjustments were straightforward. Consumer price goods baskets were relatively uniform, and other stores of value like gold and commodities had direct links to the industrial economy. Equity values were reflected in the share prices of the companies in the Dow Jones Industrial and Dow Jones Transportation Averages. The transition from an Industrial Economy to a Digital and Information Economy, however, created a gap that made real price measurement adjustments difficult. Software businesses like Microsoft simply do not need the same amounts of tangible property, plant, and equipment as industrial companies like Caterpillar in order to drive business value. Fortunately, the universe created cryptocurrencies, and thereby provided the modern analyst additional tools for measuring real values. I believe real price estimates can now be obtained from nominal prices by conversions into gold for tangible assets and conversions into bitcoin for the goodwill, patents, trademark, network values, and other intangible assets associated with technology and service businesses.

Under my Bitcoin, Gold, Dow Theory Framework, first published in 2017, I postulate that the value of one gold coin, plus one bitcoin, will approximate the value of one Dow share over time. This has largely proven correct to this point in time. In this framework, tangible book values and centrally directed interest rates are easily measured and change infrequently. Meanwhile intangible values like patents, trademarks, network effects, and inflationary values of more difficult to accurately price. Logically this suggests that the volatility of gold should be lower than the volatility of equities, the volatility of cryptocurrencies would be higher than equities, and the volatility of equities would reflect a blended volatility based on the ratio of tangible to intangible values of the businesses. A fourth factor in all asset values would be the asset price inflation monetary gap. Finally, the analyst must make a determination as to the appropriate discount rates to use.

Since my last report, interestingly, the market has also developed a new free market interest rate mechanism for the technology economy in DeFi and Staking rates.

Does this type of analysis work?
I will let the reader decide for his or herself, but I would point out that my analysis has correctly identified two technical points of resistance for the Dow Jones Industrial index, one technical point of support for the stock Index, and correctly identified the most undervalued asset classes consistently over the last 5 years. I began this real time experiment and have posted all reports on Bloomberg. I am updating this year’s analysis because equity markets are again pushing against the upper ranges of my price range estimates. Here are my words from the 2019 report, a performance table to my 2020 report, and my recommendations chart with both our high and low recommendations charted since 2015.

What I Wrote in December 2019

“Much like last year’s analysis, the current low levels of dividend and earnings yields and interest rates suggest a fair degree of caution….Based on an earnings retention rate of 54.08% and a return on average equity of 21.3% the implied expected book value growth for 2020 would be a solid 11.52%, which when added to an initial 2.22% dividend yield would led to an expected 13.74% total return under average conditions. While impressive and consistent with historical ranges, I continue to point out that this may represent near peak conditions.”

I continued with the following:
“I am less confident in the analysis now, however, given the suppressed nature of global interest rates, as both equities and bonds may be mispriced…Prices close to 21,760 would be low in relation to past multiples…”

Furthermore, I continued and introduced the reader to my Bitcoin Gold Dow Theory.

Under the headline Nominal v. Real Prices, I provided the following:

“I think the value of one gold coin plus one bitcoin will approximate the value of one Dow share over time. This implies a bitcoin target price of $21,532 and a gold price of $6,512.”

Mid – 2021 Analyst Highlights

• Our current analysis suggests levels below 30,322 on the Dow Jones Average would be considered below average, while a level closer to 23,933 would represent low prices, while an index level of 36,711 would be considered rich in relation to past sales, earnings, book value, dividends and forward analyst estimates. Given the current risk to reward ratio, FinTrust is maintaining its rating recommendation to HOLD for the Dow Jones Industrial Average exchange traded fund (ETF symbol: DIA), as the market is currently 15.6% above the midpoint of our 2021 estimated price range and the risk-reward ratio is poor.
• I am decreasing my recommended equities asset allocation, as the data suggest an allocation for defensive investors of 40/60 currently. Equities are currently 15.6% above the midpoint of our estimated valuation range, while gold still appears undervalued relative to equities. Should equities continue to trade higher from here toward the top of our estimated price range, I would recommend investors proportionately decrease their equity allocations. Conversely, should equities trade lower from here, I believe investors should proportionately increase their equity allocations.
• Today, the tangible book value of the Dow sits at $6,688, so I am maintaining my gold price target of $6,688.
• Today’s Dow Price of $35,144 less our gold price target yields an implied bitcoin target price of $28,372.
• As in our previous reports, the data suggests that for the “defensive investor” reasonable allocations, toward the common stocks of the Dow Jones Industrial Average levels appear appropriate and reasonable. For fixed income investors, I continue to recommend inflation protected, tax-free, floating rate and high-quality bonds, while for aggressive investors I recommend gold equities, gold, and cryptocurrency in place of short-term fixed income and money market holdings.

Risks to the Recommendation:

• Risks include, but are not limited to, (1) Unanticipated changes in inflation, interest rates and industrial production (2) credit risk (3) regulatory, governmental, and tax law changes (4) product and business risks (5) the mere fact the future is uncertain (6) political risks (7) and all other risks normally associated with investments in common equities.

Important Disclosures:

Analyst Certification: I hereby certify that the views expressed in this research report accurately reflect my personal views about the subject company(ies) and its(their) securities. I also certify that I have not, will not, nor are presently receiving direct and/or indirect compensation in exchange for any specific recommendation in this report. In addition, said analysts has not received compensation from any subject company in the last 12 months.

Ownership and Material Conflicts of Interest:

An analyst or a member of his household may not purchase the securities of a subject company 30 days before or 5 days after the issuance of the research analyst’s report or a change in ratings or price targets, trade inconsistent with the views expressed by the research analyst, and all transactions in the subject company (ies) securities for the research analyst’s personal trading account must be approved.

The research analyst nor a member of his household own any of the securities of the subject company including any options, rights, warrants, futures or long or short positions. Neither the research analyst nor a member of his household own 1% or more of any of the securities of the subject company based upon the same standards used to compute beneficial ownership for the purpose of reporting requirements under 13(d) of the Securities Act of 1934, as amended. However, at the time of this report, accounts managed by Mr. Gillespie, including but not limited to the FinTrust Income and Opportunity Fund, in which Mr. Gillespie is a shareholder, own shares or options Cisco, Intel, Goldman Sachs, Apple, and Microsoft, and various clients of the firm also own other shares referenced in this report. In addition, Mr. Gillespie owns bitcoin and various cyrptocurrencies at the time of this report.

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