Sunday, September 15, 2013

Stock Market: Dow Jones II - A Defence

(Drivebycuriosity) - Last week the Dow Jones Average got a makeover (I commented this here driveby). The revamp prompted a lot of fundamental critics on the Dow (for instance washingtonpost). I believe that these objections have some intellectual merits but nonetheless I want to write a defense:

1. The critics complain that the Dow has just 30 stocks. Therefore the barometer doesn´t represent the huge U.S. economy and the whole stock market. The detractors prefer instead the S&P 500, that - as its name says - captures around 500 stocks.

2. Many important companies are missing in the Dow. There is no Google, no Apple, no Amazon and no Ebay. Therefore the Dow cannot be a mirror of the U.S. economy, the critics complain.

3. The Dow Jones is not really an index, which is a mathematical construct (wikipedia). The barometer, inaugurated in the year 1896, is just calculated as an average (as its name says). Companies are weighted by their stock prices, not by their values (market capitalization). Therefore IBM - with a current stock price of around $192 - counts around 5 times than Coca Cola with a stock price near $39 - even that their value (market capitalization) is close (IBM $210 billion, Coca Cola $170 billion). This explains the exclusion of Google ($889 ), Apple ($464) and ($297). Those stocks would dominate the average by far.

I agree, the Dow is ridiculous and seems to be antiquated. But if it is not broken, don´t fix it.

Siamese Twins

The barometer did well the 117 years of its existence and reflected the ups and downs of the U.S. since its inauguration in the year 1896 (ritholtz).  If you go for instance on the Google Finance page and compare the 10 years charts of the Dow with the chart of S&P 500 (you can add the S&P to the Dow or the Dow to the S&P ) you'd don´t see much of a difference (google). Both charts move together like siamese twins.

And the Dow Jones is by far the oldest stock market barometer and the world´s most popular. Therefore the mother of all stock market indices is a valuable source for historians and for all who are interested in the long run history of stock markets. Carry on good old Dow.

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