Wednesday, October 18, 2017

Chart of the Day: Not So Fast Folks

I take the opportunity at each client review meeting to bemoan the public emphasis on the Dow Jones Industrial Average. We're talking a market benchmark that consists of merely 30 U.S. stocks and, to make matters stranger, the index is price weighted -- the stocks with the highest share prices have the largest impact on the Dow's performance. 

Consequently, the largest company on the planet, Apple -- in terms of its impact on the index -- plays 7th fiddle (virtually tied with IBM)  to, in order of impact, Goldman Sachs, Boeing, 3m, United Health, McDonalds and Home Depot. 

To get a feel for the oddness of price-weighting, Apple, by total market capitalization, is 8.5 times larger than Goldman, 5.5 times larger than Boeing, 6.5 times 3m, 4 times United Health, 6 times McDonalds and 4 times Home Depot. Oh, and 5.5 times IBM, which sports a share price presently within a dollar of Apple's. 

Consequently, the Dow often offers up a false representation of what's really going on inside the U.S. equity market. Like so far this month:

Click to enlarge...

While the Dow's up a whopping 1.5% with nearly half the month left, the S&P (505 stocks [size-weighted]) and the Nasdaq Composite (3,000 stocks [size-weighted]) are just above the flatline, while the Russell 2000 (2000 smallcap stocks [size-weighted]) is actually in the red.

Today, in fact, is a perfect example: The Dow's up 136 points (0.60%) as I type, while the S&P and the Nasdaq Comp are essentially flat (up 0.1% and 0.06% respectively). The Russell 2000 is doing a bit better (than the latter), up 0.26%. 

Interestingly, while the Dow appears to be rallying hard on the morning, a look inside tells a different story. At the moment, exactly one-half of its members are actually trading lower. So today's move doesn't even legitimately reflect what's going on within the index itself!

I imagine that when Charles Dow designed the then 12-stock "Industrial Average" (1896), price weighting made sense. I mean, it was certainly better than any other benchmark at the time -- being that there were no other benchmarks at the time. Clearly, today, there are much better indexes to track.

So, while we like the present setup for equities, contrary to what the headlines might have you thinking, October, thus far, has been nothing to write home about. 

No comments:

Post a Comment