As a continuation of what I started yesterday, I figured it would be a good day to try and get back into this writing thing. So my plan this month will be to write something daily about whatever strikes me as important, and with all the craziness in our world right now, I don’t anticipate running short of topics, but expect me to touch on a variety of things that aren’t all about what is happening in Washington, DC.
Something really irritated me last week. A stock index — or more accurately an “average” — crossed a meaningless plateau that means absolutely nothing about the state of our economy and the performance of our stock market. Yet when the Dow Jones Industrial Average (DJIA) crossed 20,000, all of financial media lost their collective minds, and a lot of armchair financial pundits claimed that it reflected on “investor confidence in the economic policy of President Donald Trump.” (I put that in quotes, not because I found that particular phrase in any article that I read, but because I know that somebody used that phrase in an article celebrating this truly nothing event.)
For the average American, the DJIA represents the stock market, a number that the local news reports on every night after the stock market closes. But it really doesn’t. If you look at the history of the DJIA — something I did back in my days as a financial writer — it started out as a means to track the “leading U.S. industrial companies of the late 19th century.” But if you take a look at the list of companies now figured into this average looks a lot less industrial, instead reflecting more of the “new economy” companies that drive our economic engine.
Granted, the U.S. economy is no longer primarily based on industry and manufacturing, despite still being one of the world’s largest maker of things. But there really is no rhyme or reason for a company to be added to the Dow, other than the complete bias of the folks running the index. The S&P 500, which includes the 500 (currently 505) largest U.S. companies by market cap and encompasses about 80 percent of the total U.S. stock market capitalization, is a much better proxy for the market, but apparently it’s not nearly as sexy to report when the S&P 500 crosses 2,500 or whatever.
My main problem with the headlines trumpeting “Dow 20k” is that the math behind the index is not indicative of actual economic performance. Whereas the S&P 500, the best approximation for performance of the stock market, is computed based on a weighted average of the market caps of the 500(ish) stocks included, the DJIA is a price-weighted index, simply adding us the current share price and dividing by some random number.*
*This random number is the Dow Divisor, and started out at 16.67 back in 1928. It’s been adjusted numerous times since then because of splits and dividends and now sits at 0.14603483 (give or take a few decimal places).
The arbitrariness of this math shouldn’t be ignored. The folks behind the DJIA can simply manipulate the performance of the index by adding high priced stocks, something they did when they added the likes of Goldman Sachs and Apple, among others. For example, Goldman Sachs is currently the highest priced stock on the Dow, with a recent closing price of $230.67 a share, meaning it accounts for nearly 8% of the Dow’s total value. However, if we rank the 30 Dow stocks by their market caps — a better metric when determining relative size compared to other companies — Goldman Sachs is the 24th largest component of the DJIA. Meanwhile, General Electric, the 6th largest Dow component by market cap, currently has the lowest share price, and is thus only 1% of the Dow’s total value. I don’t know about you, but I feel like the things that General Electric does is more reflective of “industrial” than Goldman Sachs, the “vampire squid” of investment banking that barely affects anything the bulk of The 99% does every day.
While it is important that certain things in the financial media can and should be used as indicators of the health of the U.S. economy, they should not be the only factors. The next time that a financial newscast leads off with the Dow hitting record highs, you should simply turn it off. The average American investor shouldn’t be tracking the day-to-day movements of the market anyway; the safest way to maximize your investment return is to dollar-cost average into the S&P 500 over a long time starting at the earliest possible point in your life.* Everything else, ultimately, is just noise.
Until next time…
*Disclaimer: This is not to be construed as investment advice of any kind, though you really can’t go wrong doing this. Buying individual stocks is not hard, but it is not necessarily easy and should only be something done if you have the time and risk temperament to do so. Regardless, you really shouldn’t read just one thing and decide how to invest your hard earned money, but instead use multiple sources to find ideas and learn about investing.