Is the market up? Down? Unchanged? Most people (the media included) would say the Dow Jones Industrial Average (DJIA) is up or down such and such, and years ago there was good reason to focus on the DJIA.
Times have changed and the Dow is no longer so important or even an accurate reflection of what’s happening. Here’s why:
The Dow, which dates back to 1896, is comprised of just 30 stocks and can often mislead investors. For example, on January 22 the Dow fell 41 points, yet there were nearly twice as many stocks rising as falling.
A decline in one Dow stock (IBM) accounted for all of the 41 points. On that day the DJIA was irrelevant.
A bigger problem is that price changes in high-priced stocks have far more impact than those in lower-priced stocks. After all, a two-percent decline in a $200 stock would be four points, which would impact the DJIA by about 30 points.
A 2 percent decline in lower-priced Cisco or Intel would be only 45 cents, the impact of which on the DJIA would be a mere 3 points.
High-priced stocks have a disproportionate influence on the Dow. The four highest priced stocks — Visa, IBM, Goldman Sachs, Boeing — account for 29 percent of the Dow’s price movement.
Meanwhile, low priced stocks — Cisco, Intel, General Electric, Pfizer — only account for 4 percent of the Dow’s movement.
Price-weighting is not a new problem and in fact has always been the case, but Dow Jones recently made it worse. Last September Dow Jones removed Alcoa, Hewlett-Packard and Bank of America — all low-priced stocks — from the DJIA and replaced them with Goldman Sachs, Visa and Nike, high-priced stocks.
That move alone significantly increased the volatility of the Dow Industrials and we’re seeing that day after day. Expect more.
Here’s my advice: Ignore the Dow Jones Industrial Average and focus on the S&P 500 Index. A measure of 500 stocks, not 30, better reflects the market.
So when you ask someone, “How is the market today?” and they say the Dow is up this or down that, ask about the S&P 500, a far better measure, one professionals use exclusively.
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.