Is the Dow a good market indicator?
The Dow Jones Industrial Average includes a number of companies whose stocks haven't exactly been stable -- Bank of America and General Motors to name a couple. With all that volatility, is it really an accurate representation of the overall market? Jeremy Hobson reports.
Traders work at the New York Stock Exchange in New York City, as the Dow Jones Industrial Average takes a dip (Stephen Chernin/Getty Images)
More on The Economy, Wall Street
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BOB MOON: If you're here for The Numbers, we'll get to them in just a bit. But the won't explain some, shall we say, interesting stock market swings you may have noticed in the past few days.
Lately, we can all count on the Dow Jones Industrial Average for the quick thrill -- and not necessarily in a good way. To understand these latest lurches, consider this: The Dow reflects an average stock value of just 30 of the largest U.S. companies. Thirty . . . out of more than 10,000 companies in this country. And it's "price-weighted," which means the price of just one of those stocks can have a lopsided effect in determining the average.
So a week like this one raises anew this question: Is the Dow a reliable indicator of what's happening in the stock market? Here's Marketplace's Jeremy Hobson in New York.
JEREMY HOBSON: James Angel is a finance professor who studies the stock market at Georgetown University. He says because of the formula the Dow uses . . .
JAMES ANGEL: Everytime a Dow stock moves by a dollar, the index will move by approximately eight points.
Which means if one of the Dow's expensive stocks like IBM falls by 20 percent, it will drag the average down by a lot more than the same movement by one of the Dow's cheap stocks like Bank of America. Hence, the daily volatility of the Dow -- and its differences with the broader S&P 500 index.
But, Angel says . . .
ANGEL: As you've noticed, these indices tend to go up and down together.
That's true over the long term. Though any Marketplace listener knows that about once a week, the indexes end up doing different things, and you hear this:
[MUSIC: It Don't Mean a Thing If It Ain't Got That Swing.]
No reason to distrust the Dow, says John Prestbo, the executive director of Dow Jones indexes.
JOHN PRESTBO: When you're looking at just one day at a time, you're capturing a lot of what the statisticians call noise, which is meaningless movement that has no significance for the longer term.
So what do the pros use? Here's financial analyst Peter Cohan.
PETER COHAN: I compare my stock picks to the S&P 500 rather than the Dow.
Though he admits the two indexes are not that far off. And he says if you want an index that'll really tell you what the market's doing right now . . .
COHAN: It would probably consist of pawn shops, head hunters and bankruptcy and restructuring firms.
In New York, I'm Jeremy Hobson for Marketplace.
Comments
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From Hudsonville, MI, 02/13/2009
For the benefit of us neophytes, how about a future story on how the various stock indices were developed and how companies are selected for listing?
From East Brunswick, NJ, 02/09/2009
The Dow is not a faulty indicator. It took a harder series of blows when financials and autos first cratered. Since these companies' stocks are down, the Dow has less distance to fall. That is a statistical norm (and an obvious fact for non-math folk).
Moreover, GM and Citi still employ hundreds of thousands and produce enormous amounts of products and services for millions of people. You cannot just dismiss them bc the prices are down.
Also, the Dow has included Nasdaq stocks for some years because they are mega stocks which affect the economy. it has not been NYSE only for years.
Note to author: there are not 10k stocks traded in US today. There are about 4700. The DJ Wilshire 5000 covers every single stock traded on any US exchange and that is how many it covers today.
From Winston-Salem, NC, 02/06/2009
Great idea! Let's just ignore the Dow index. By the way, it includes at least one stock (Microsoft) that's traded on NASDAQ, so how can the index be a proxy for the NYSE?
From Westwood, NJ, 02/06/2009
I agree with Chris. Why do we keep watching a faulty indicator? There are alternative measures to use if the media has the courage to suggest them. Take the lead, Marketplace!
From Raleigh, NC, 02/06/2009
I listen to your show every day, but involuntarily roll my eyes back in my head every time you get to that part of the show where you tell us what the DJIA did today.
Instead of talking about how the DJIA isn't very useful, why don't you just stop talking about it every day? It is shows like this one that perpetuate the myth that the DJIA is a worthwhile index to follow. Many (most?) listeners assume that if you're talking about it, it must be important.
Chris
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