Measuring the Market

“So how’s the market?” Most likely whoever you ask will tell you how the Dow Jones Industrial Average is doing. The Dow has been around since 1884 when Charles Dow first published a list of stocks in his Customer’s Afternoon Letter.  The Index morphed into the Industrial Average in 1896 (see below) and the Dow Jones Company, the editors of the Wall Street Journal and now S&P Dow Jones  have been managing the list since.

The Dow is a real throw back. It tracks only thirty stocks and none of these are the newer, high flying names. No foreign stocks and until about fifteen years ago, only New York Stock Exchange issues. The Average is price weighted meaning a $100 stock has 10 times the influence of a $10 stock. This is considered amateur compared to the Standard & Poor 500 which is capitalization weighted.  Apple is the most valuable stock in America today measured by market cap and it has finally been added to the Dow, bumping off AT&T.  Changes to the Dow are not made often. The last one was September, 2013.

People often ask, how can just 30 stocks reflect accurately what is happening in an economy with maybe 5,000 traded companies? The interesting, or maybe amazing thing is, the Dow does a very good job measuring the market’s movement. The chart below shows the average annual total return of the Dow for the last five, ten and fifteen years compared to the Standard & Poor 500 and the Russell 3000, two broader based averages professionals follow.  Note how closely the Dow tracks the other indices.

Critics of the Dow view it as a lagging indicator. Companies like Apple or Microsoft or Intel are not put on the list in their early days of growth (see chart to the left below for Apple) but only after they have achieved success. Still the Dow tracks very well.  

then and now pg2.jpg

Some contrarians see a Dow promotion not as a seminal achievement but as a curse - “the Curse of the Dow”. American International Group (AIG) and Bank of America were both added to the Index just prior to the housing bust of 2008. Hewlett-Packard, Microsoft and Intel were added just before the tech crash of 2000 and right before PC’s came under intense pressure from the mobile world.  So what does the addition of Apple to the Dow say about its glory days? Will the Chinese eat their lunch or will the Apple Watch and other products simply continue the long string of successes for the company? Sorry, but only time will tell on this one.

You can slice and dice the market any way you want today - by size of company, by industry, by style of investing, etc. But the Dow, the People’s Index, still does a good job of telling you which way the wind is blowing on Wall Street.