The Dow Jones Industrial Average (DOW) is nothing more than an index of carefully picked stocks whose relevancy as to how well the stock market and economy are doing is misleading. Perhaps decades ago, it was a useful tool since it was comprised of the major industrial companies within the United States such as steel companies and auto manufacturers, (hence DOW Jones “Industrial” Average), but that isn’t the case anymore.
Within the United States, there are roughly 5,000 companies traded on the stock exchanges. However, the DOW is composed of just 30 stocks. After a little math, one quickly deduces the 30 DOW stocks only represents 0.6% of the overall total. This hardly seems like a quorum by which we can gauge the health of the overall market and underlying US economy.
This next part may seem kind of bizarre to some. Those 30 stocks that make up the DOW are hand-chosen not by economists or financial firms, but rather by the editors of the Wall Street Journal. Yeah, the left-leaning popular newspaper (I don’t say that to demean liberals. I’m just pointing out there is a clear bias. No different than if the editors of Fox News picked the DOW companies). How are editors of a newspaper qualified to pick the stocks which are supposed to best represent the overall stock market and health of the economy? They aren’t really, but over the years the entire planet has blindly and continually accepted the editors choices to be the barometer by which the entire world invests and divests its money.
How exactly do they chose which stocks are added to the DOW average? No one really knows except the editors of the Wall Street Journal, and this is where it gets a little sketchy and misleading. If one company isn’t performing well, say Kraft Foods (which was in fact recently removed from the DOW because it was performing poorly), the editors can simply vote to have that company removed from the DOW index and replace it with a different company. One which is performing well.
If the editors can simply replace a poorly performing company with one that is performing well, then the DOW increases creating the impression the overall market is doing well. But is that really indicative of the underlying health of the market/economy when they can simply choose not to include the poorly performing companies and industries? No, not at all. This is exactly what hedge fund and mutual fund managers do except they at least have a hundred or more companies in their indexes. Why isn’t the world looking at a PIMCO, Gabelli, or Vanguard fund to determine market health?
To further inject bias, all 30 companies listed in the DOW index are not equally weighted. Goldman Sachs makes up 7.31% of the total weight of the entire DOW average. IBM comes in second at 6.2%, so both companies added together represent roughly 14% of the overall weight. The top 5 companies represent 30% of the overall weight. If Goldman Sachs, IBM or 3M have a good day, the entire DOW index could be shifted upwards, but is that indicative of the entire market? Clearly not.
Furthermore, when news hits the street that a particular company is getting added to the DOW index, the stock price jumps significantly creating a rise in price that has nothing to do with company performance. This in turn causes the DOW to jump in value. Conversely, the stock that is replaced usually drops in price, as was the case with Kraft Foods.
Here’s the list of companies currently averaged within the DOW (as of 4/26/2015):
Notice anything odd about this list? The DOW is supposed to be an average of the Industrial companies, but where are they? Where are the steel companies? Where are the automotive companies such as Ford, GM, and Chevrolet? Where are the housing companies? Where are the airline companies? Where are the shipping companies? These industries represent the backbone of the entire US economy yet they are mysteriously absent from the DOW. Why is this? It’s simple; they are not performing well. So how can the DOW represent the industrial health of the US economy when none of the poorly performing industries are represented in the DOW average? Answer; it doesn’t.
I don’t want to give the impression there is some kind of conspiracy taking place. I don’t believe that to be the case at all. The only thing I’m trying to point out is that the DOW is nothing more than a biased representation of how well the overall market is doing based on what a few editor’s think at The Wall Street Journal, and I find it perplexing that so many people, and countries all around the world, trust the DOW as the barometer for how well the US economy is doing. It can easily be manipulated to give a false representation of the United State’s economic health.
So I’ll finish this entry with a few questions: How is the airline industry doing? How is the automotive industry doing (think Detroit)? How is the steel industry doing? How is the coal industry doing? How is the shipping industry doing? How are the energy companies doing? How is manufacturing doing? How are construction companies doing?
Answer(s): Not well, at all.