It’s widely quoted, represents the face of the stock market to the masses, and closed at a new all-time high yesterday. But that doesn’t change the fact that the Dow Jones Industrial Average, for all its storied history, is irrelevant.
The observation is unchanged by yesterday’s news that it eclipsed its old high of 11,722.98 set on January 14, 2000 by settling at 11,727.34. Yes, the Dow makes for interesting copy in the newspapers, as a review of the media today reveals. Nonetheless, the hoopla is misplaced. Indeed, the Dow’s ascent into record territory stands alone today among the broad measures of U.S. stocks. Notably, the S&P 500 and the Russell 3000 remain well below their peaks of early 2000.
Ditto for the Nasdaq Composite, the fallen poster boy for tech stocks. In fact, a new high for the Nasdaq may have a long, long wait. Breaching the 5000 level briefly in March 2000, the Nasdaq is still more than 50% below that ancient summit.
The S&P 500 and Russell 3000 are much closer to their previous crests. Nonetheless, equities would have to rally long and hard from here to deliver a new high in these indices, both of which command far more respect and money in the institutional investor community than the Dow. In fact, no one in their right mind would consider using the Dow Industrials as the basis for an index fund for serious money, which is why there’s precious little money attached to the benchmark compared to the alternatives.
The value of the Dow, if one can call it that, is mainly that of an antique curiosity. The world’s first stock index, the Dow Industrials trace a history back to 1884, when Charles Dow began publishing a measure of market activity in the “Customer’s Afternoon Letter,” the forerunner to what would become The Wall Street Journal. In the 19th century, the limitations of technology demanded a relatively simple methodology for sampling equity price changes writ large. The Dow, as a result, is today a prisoner of those archaic confines.
The modern Dow Industrials is the world’s most recognized stock index, but the benchmark exists by virtue of its lengthy history as opposed to any compelling relevance. Looking at the Dow is like peering back into time. This, dear readers, is an index that is bottled in a methodological formaldehyde, preserved for the ages for no particular reason beyond the fact that it’s been around longer than its competitors. Even Dow Jones & Co., which owns the index, has long since recognized the obvious by publishing a modern suite of benchmarks of relevance.
Yet for all its flaws, we still have a warm spot for this old index, which conjures a time of researching the market by poring over the evening newspaper and breaking out graph paper to mark the latest high, low and closing price of the day’s market action. And so, like many investors, we still keep an eye on our old friend, respectful of its past and mindful of its irrelevance for deploying capital in the 21st century.
First among those flaws is the fact that the Dow represents a mere 30 stocks. Yes, those are blue chip stocks, as they say, but the 30 are too few to represent the mass of equity that is the American stock market. In fact, it’s worth pointing out that only 10 of the 30 Dow stocks hit new highs yesterday.
Adding insult to injury, the calculation method behind the Dow is hopelessly convoluted, a vestige of trying to maintain its original simplicity as a simple average after decades of dividend payouts, mergers, stock splits, and random membership changes by the editors of The Wall Street Journal, which decides who’s in and who’s out.
To be sure, the S&P 500, the Russell 3000 have their own flaws. But the difference is that the Dow’s flaws are fatal while the S&P and Russell’s flaws are relatively minor. At least, that’s the conclusion based on investors who vote with real money. Nonetheless, some argue that the market-cap thinking that informs the calculation of the S&P and Russell 3000 is in need of change. A number of alternatives are now available, including an ETF that’s an equal-weighted version of the S&P 500: Rydex S&P Equal Weight ETF (AMEX: RSP); and a fundamentally weighted ETF: PowerShares FTSE RAFI US 1000 (NYSE: PRF).
Then again, for those who revel in the old days, there’s always the option of buying the Dow, which is available as an ETF: Diamonds Trust (AMEX: DIA). Indeed, given the Dow’s relative outperformance, the old index may be facing a renaissance of renewed interest. And for the moment, what’s not to like? The elderly benchmark is showing up its younger rivals with superior performance. But for those looking for a representative sample of U.S. equities, it’s best to look elsewhere.
We love the Dow, and all it represents. But just don’t ask us to invest in it.
That was a good read.