Stock Watch


I (Heart) the Dow

Jeffrey R. Kosnett

There’s a lot to love about the often-maligned but impossible-to-ignore Dow Jones industrial average.



It's so easy to lampoon the Dow Jones industrial average that to praise it in front of serious investors and financial advisers risks exposing myself as dumb and naive. But I'm going to do it anyway. Let me say loud and clear: I love, love, love the Dow. I want it. I need it. I wish Frankie Valli would do a song. Or Neil Diamond. Or Elton John.

I’m aware that the Dow’s price-weighted formula would get laughed out of a brainstorming meeting of today’s financial engineers. When Charles Dow launched the industrial average in 1896 with a dozen stocks, he simply added up the share prices and divided by 12. Now, the only difference in the formula is the total number of stocks (30) and the divisor, which has evolved over time to reflect stock splits and changes to the Dow components.

I’m also aware that the Dow’s “industrial” mix doesn’t accurately define contemporary commerce. The Dow has no Apple (symbol AAPL), no Google (GOOG), no Amazon.com (AMZN) or, if I’ve already got you yawning, no Starbucks (SBUX). That’s a shame. If more new-economy stalwarts could matriculate sooner into the Dow, the index would be thousands of points higher. This wouldn’t necessarily mean we’re in a bubble. The total value of all publicly traded shares wouldn’t change, but public confidence in stocks -- and the recognition that the entire U.S. economy isn’t failing -- would be dramatically higher.

Instead, the Dow includes the likes of Microsoft (MSFT) and Wal-Mart Stores (WMT), excellent businesses whose shares made people rich back in the day but haven’t done jack for stockholders since their induction into the index late in the 1990s. Because its proprietors, the officials at Dow Jones Indexes, make as few changes as they can, they are loath to consider any company until after its fastest expansion phase -- see Cisco Systems (CSCO), Dow class of 2009, the replacement for General Motors (GM). So the average has its share of slow growers and has-beens.

Advertisement

At least Cisco, which is in a nest of trouble, is only about 1% of the average. That’s because its share price is just $15 and change, and the Dow’s formula weighs high-priced stocks more heavily than low-priced shares. Only Bank of America (BAC) has less influence than Cisco on the index’s daily value. IBM (IBM), the highest-priced Dow stock, is about 10% of the average. Google, at $500, would be three times as powerful as IBM if it were a component, due to its extraordinarily high share price. (By contrast, Standard & Poor’s 500-stock index is capitalization-weighted, meaning it’s calculated using market value -- stock price times total shares outstanding -- rather than stock price only.)

It’s All About the Dow

But enough carping. The Dow Jones industrial average is the stock market’s unquestioned mainline to American popular culture. Why else would it be in so many book titles and the name and theme of a Broadway musical, “How Now, Dow Jones.” For its popularity alone, I’d rank the Dow average alongside such brilliant late-19th-century inventions as baseball, the bicycle, the telephone and the Brooklyn Bridge. It’s the one financial figure written and broadcast daily in every language. It tells billions of people around the world what’s happening in America’s economy and financial markets and, much of the time, what’s next for their own.

In any financial accident, crash or panic, all eyes turn to the Dow. Few people care how many points the S&P 500 or some international index, such as the MSCI EAFE, drops -- or recovers if the storm passes. It’s always the Dow. There’s a gripping video clip from the May, 6, 2010, flash crash starring a trader of S&P 500 futures in the Chicago markets who suddenly yells “1,000 Dow points,” and you get the idea that this episode is out of this world. How many points did the S&P 500 fall and rise in those 20 minutes? Oh, the percentage was about the same. But if you were otherwise occupied and heard someone yell “the market [meaning the S&P] fell 150 points in a few minutes,” I bet you’d think, “So?”

Maybe I’m a sucker for round numbers instead of percentages. I quietly perk up when the radio tells me at 5:30 a.m. that Dow futures suggest the market will open up 75 points, even though 75 isn’t overwhelming with the index at 12,000. I’m rapt before my computer screen in the last half-hour of trading because the Dow so often bounces up or down 100 points. You probably know the index today is near 12,000. A few of you might even know it peaked at over 14,100 in October of 2007. Who but professionals can (no looking) say where the S&P 500 is at any time, tell its peaks and valleys, or describe the Wilshire Index, that favorite of purists and professors?

Happy 115th Birthday, Dow!

My affinity for this funky old average led me to attend a conference in May that the Dow Jones Indexes people held to observe the average’s 115th birthday. (115th? I’m telling you, this thing is mighty quirky.) No big economic news, no companies coming or going, and absolutely no chance that the Dow Jones Indexes organization would yield to changing times and admit Apple and Google without a split in their share prices.

Rather, the Dow brass, led by John Prestbo, an old Wall Street Journal reporter who is editor and executive director of all Dow Jones indexes, just wanted to have some fun waving their flag before a bunch of largely European and Asian journalists. Dow Jones got an investor relations guy from General Electric (GE) to say some pleasantries about how proud GE is to be the last charter member of the index still there. A couple of scholars defended the index by noting, to my surprise in light of the no Apple-no Google situation, that the Dow correlated 95% with the S&P 500 for the last 25 years and 95% in the decade of the 2000s. I’d have guessed it was less than 90%. Over the past 20 years (through July 7), the Dow has bested the S&P 500 by 1.3 percentage points per year.

Prestbo explained that the Dow changes less than once a year in part because if Dow Jones did boot more shrinking members, the investing public might believe that the incessant lobbying and public relations by companies eager to be selected pays off. It doesn’t, but frequent changes would call the Dow’s impartiality into question anyway. On the question of why to add Cisco or Microsoft after their stocks downshifted, Prestbo said it’s not the job of the Dow’s guardians to pick the next stock-market winners, but to recognize business excellence. The Dow Jones industrial average, he repeated, is neither a mutual fund nor intended to be your ideal portfolio. You can invest conveniently in the Dow in the form of an exchange-traded fund, SPDR Dow Jones Industrial Average (DIA), but unlike other indexes that are designed to be investments, this is best used as an indicator.

It’s also not a prophecy. In 1896, Charles Dow seeded the original industrial average with leather and sugar and tobacco -- and General Electric -- although Americans were not many years from driving and flying and were already gabbing on the telephone. If the Dow were to be the model for a growth portfolio, I suspect old Charles would’ve found a spot for an oil company or someone tinkering with car parts. He didn’t. But we still pay daily, sometimes hourly, attention to his flawed but likable, charming, mesmerizing number that closed on July 7 at 12,719.49.



Editor's Picks From Kiplinger


You can get valuable updates like Stock Watch from Kiplinger sent directly to your e-mail. Simply enter your e-mail address and click "sign up."

More Sponsored Links


DISCUSS

Permission to post your comment is assumed when you submit it. The name you provide will be used to identify your post, and NOT your e-mail address. We reserve the right to excerpt or edit any posted comments for clarity, appropriateness, civility, and relevance to the topic.
View our full privacy policy


Advertisement

Market Update

Advertisement

Featured Videos From Kiplinger