Can We Please, Finally, Retire The Dow?

By Steve Sosnick, Chief Strategist, Interactive Brokers

This morning’s pre-markets showed a wild divergence: the S&P 500 Futures were on a gentle climb upward, while the Dow Jones Futures were indicating as much as a -200 point loss. The cause of the divergence was obvious to long-time market participants – Boeing (BA) shares were trading 10% lower, and it has a disproportionately high weighting in the price-weighted Dow.

Simply put, the Dow Jones Industrial Average (DJI) is a relic. I have held this opinion for years, and I know that I am not alone. I once asked a producer at a major financial network why they kept featuring the Dow in their market updates, and he replied essentially that they needed to do so because viewers expected it of them, even though most professionals knew it was obsolete.

A bit of history is appropriate here. In 1885, Charles Dow, editor of the Wall Street Journal, and one of his associates, Edward Jones, created the first stock market index. It was a worthy endeavor, as there previously was no accurate way to measure the stock market’s performance as a whole. The methodology was appropriate for the computational technology available at the time – a pencil and paper. They took an arithmetic average of the original 14 components and reported it to their readers. That original index was primarily railroad companies (the hot, growth sector of that era), and in 1896 they created the 12 stock Industrial Index. Over the ensuing decades, the 12 components became 30, and the divisor was adjusted as splits and composition changes occurred.

Yet the index’s main deficiencies remain. For starters, 30 stocks are too few to properly measure the aristocracy of the US equity markets, let alone the markets as a whole. Also, price weighting has proven to be a very poor index methodology. A stock’s price may bear little value to its value. A company with a high priced stock and a small float may be worth less than one with more outstanding shares at a lower price. That adds an unnecessary element of randomness to a price-weighted average. Should a $400 Boeing be 10 times more important than a $40 Pfizer (PFE)? I’ll argue absolutely not! Both PFE and BA have market capitalizations of roughly $225 billion. Similar percentage moves in both have similar effects on investor wealth, yet that move in BA has 10x the effect on INDU as PFE! Both stocks have a roughly 1% weight in the S&P 500 Index (SPX), yet BA has a 10% Dow weight compared to PFE’s 1%. 

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