Photo: Associated Press
We’re Already at Dow 30000, You Just Don’t Know It
The blue-chip index is a poor measure of what investors are doing
By James Mackintosh
It’s time to ditch the Dow. After 120 years, the venerable Dow Jones Industrial Average is an embarrassing anachronism, abandoned by professionals and beloved only by a media that mostly knows no better. It needs to be updated or, better, replaced.
The Dow was invented by a founder of this newspaper. My direct boss and his direct boss both sit on the committee that decides on the 30 companies which make up the average. And TV news has long since picked the Dow as its gauge of Wall Street activity.
But a columnist’s job isn’t to flatter. It is to present facts. And the fact is that the Dow is deeply flawed. It is not a good measure of the broad market—indeed it is not even designed to be. It is not a good guide to investing. It is not calculated in a sensible way. And it isn’t even right.
Start with the last point. Correct for mistakes dating from the days of paper and slide rule, and the Dow in fact passed 30000 for the first time last month, according to Birinyi Associates calculations.
The biggest mistake came from the simplistic recalculation of the average when it was expanded from 12 to 20 stocks. The official Dow record shows a drop of 24%—its worst-ever day—when the market reopened in 1914 after a four-month break because of the start of World War I. In fact, the market and the Dow rose that day, but the record was recalculated without any adjustment when the measure expanded from 12 to 20 stocks two years later. Because some of the new stocks added had lower prices, the new version of the average was pulled down. So, no, there really isn’t any reason to get worked up about the average passing 20000.
More important than the level is the method of calculation. The Dow is a share-price average, which was quick and easy to work out each day back when mechanical adding machines were state of the art for statistics. But share prices are arbitrary, as they depend on how many shares are issued; some companies have very high prices, which give them more influence on the Dow, even though they may be less valuable overall. Modern indexes are weighted by market value, often adjusted for the free float available, giving a better representation of the overall market or of the stocks which can be bought.
The result is that the Dow can behave very differently to the wider market, as it has in the past three months. Since the start of November, the Dow has gained 10% compared with 7% for the broader S&P 500.
One big reason: Goldman Sachs Group Inc. The Dow’s strange focus on share price gives far more weight to Goldman than the bank’s market value deserves. At $236.59 a share, it is the most expensive stock in the average, meaning it has twice as much of an effect on the average as Apple Inc., which has a market capitalization more than six times that of Goldman.
The Dow also has been helped recently by its exclusion of dull utilities or real-estate companies. Utilities, along with transport companies, are excluded on the basis that the Dow is an industrial average. Yet the measure stopped being exclusively industrial when retailer Sears, Roebuck was added in 1924.
The same reasons explain why the Dow has lagged behind the market in the bull run since March 2009. It’s true that the Dow and the S&P have tended to move broadly together, and over the past 20 years their returns have been remarkably similar.
But in other periods, the two have diverged significantly. For example, the Dow lags more than 30 percentage points behind the S&P 500’s 234% gain since the post-Lehman low.
All this makes the Dow a poor measure of what investors are doing, one of the big reasons for an index to exist.
The other big justification for any market index—or even average—is to put money to work. Here the Dow is an also-ran, as Wall Street recognizes its drawbacks. Howard Silverblatt at S&P Dow Jones Indices says only $35.9 billion of funds follow the Dow, compared with a whopping $2.1 trillion indexed to the S&P 500.
The only saving grace for the Dow is that its long history means people know what it is, helped by the choice of big-name companies as constituents. It is indisputably an icon. Even here, though, the Dow’s familiarity has become a drawback. As the Dow has risen over the years, 100-point moves—a media fixation—have dropped from being worth 2% of the index 20 years ago to just 0.5% today.
The Dow is in fact no longer owned by Dow Jones, as it was sold to a joint venture of S&P Global and CME Group Inc. in 2012. But it is too good a brand to kill off. Instead, it could become a proper measure of the market, if its name was applied to something unwieldy sounding such as the Dow Jones U.S. Total Stock Market Index. This is an excellent but widely ignored measure of what’s actually happening in the market, and would widen the Dow from following 30 stocks to following 3,850.
After more than a century of service, the Dow deserves an upgrade.