Stocks have been getting clobbered the past few days, which makes this a perfect time to talk about the prospect of Dow 18,000. The oft-cited market indicator is about 400 points away from that milestone as I write this.
Why bring this up now, when the market’s reeling? Because if I follow journalistic tradition and wait for the Dow to hit 18,000, which it will some day, my thoughts about the meaninglessness of the Dow will get buried in the hoopla when the milestone is achieved. Now, there’s a chance you might pay attention.
The Dow, you see, has symbolic significance but no real significance, and most investment professionals pay no attention to it. “The Dow isn’t a benchmark that anybody follows,” says Martha Ortiz, the O of AJO Partners, a Philadelphia money management firm that frequently analyzes numbers for me. “We don’t have a single management agreement that mentions the Dow.”
How can this be, given that the Dow is our nation’s oldest and most-recognized broad stock market scorecard? Because the Dow has barely changed since its debut in 1896, back when Grover Cleveland was president, electricity was cutting-edge technology and electronic calculators were a distant dream.
The problem lies in the way the Dow’s designed. In the real world, making or losing $30 matters more than making or losing a single dollar. But the Dow can’t recognize that fact because of the way it was constructed, and it can’t adapt to that reality without losing its continuity and cachet.
I’m talking about the difference between an average and an index. The Standard & Poor’s 500, the most important U.S. market indicator, is an index that is based on the total stock market value of its component issues. But the Dow Jones industrial average, to give the Dow its full name, is an average, not an index.
To calculate the Dow, you add up the share prices of its 30 stocks and divide by the Dow Divisor, currently the wonderfully precise 0.15571590501117. The original divisor was 12, when the Dow was a 12-stock average, the only kind of market indicator that 1896 technology could handle. But as stocks split and different issues were added and subtracted from the Dow, the divisor was changed to keep the average the same immediately after the change as it had been before the change.
So today, a $1 change in any of its 30 stocks moves the Dow by 6.422 points. If the 339 million shares of Travelers move by $1, it has the same effect on the Dow as a $1 move in General Electric’s 10.034 billion shares. If Travelers rises a buck and GE falls a buck, the Dow would stay the same — but the S&P 500, which is based on market values rather than on stock prices, would fall by about $9.7 billion.
If the Dow’s highest-priced issue, Visa, selling at $262 a share when last I looked, were to enact a 3-for-1 split, it wouldn’t make any difference in the S&P because Visa’s market value would stay the same. But the Dow would have to recalculate the divisor because that Visa split would drop the sum of its stocks’ prices by about 175 points. In order to keep the average the same, the Dow would have to make the divisor smaller, which would make each dollar move of any stock bigger.
All of these flaws explain why there are trillions of dollars of investments based on the S&P 500, and nothing remotely close to that for the Dow.
For all my ragging on the Dow, it does have one use. “Milestones like this are an excellent opportunity for you to re-evaluate your holdings,” says Howard Silverblatt, senior index consultant at S&P-Dow Jones Indices. “It’s a good time to see where we’ve gone, and where we’re going.”
So if the Dow hitting a milestone makes you think and reflect, that’s a good thing. And is about the only useful thing the Dow has to offer.
