On November 20, 2008, the Dow Jones Industrial Average (DJIA) closed at 7,552.29. To date, that remains that closing low in the market through this current bear market.
During the past two days, the market has made serious threats at setting a new closing low. The DJIA closed at 7,552.60 yesterday, less than a half a point above the previous low! And today, the index spent most of the day trading negative, before somehow finishing the day in positive territory.
It was a MAJOR test of the lows, as the technical analysts would say. It is a major resistance level, which, if breached… look out below!
There’s one small problem with this.
Why are we even watching the Dow? Why, in the year 2009, are we even talking about an index of 30 companies, which is calculated in the goofiest way of all indices? We could just as well watch the Janus 20, and call that “the market.”
Today was a perfect example of how the goofy calculation bears out weird numbers.
Consider this. The DJIA closed the day at 7,555.63, which is UP 3.03 points, or 0.04%. Not a big day, but still positive. Just enough to avoid setting a new closing low. What does this tell you about the stock market today? You would probably assume that stocks are mixed - some up, some down. Probably a bit more up than down, right?
Wrong. There were many more stocks down today than up. 2,779 stocks were up, 698 were unchanged and 5,538 were down. Nearly twice as many stocks were down than up. Yet the DJIA gained three points today.
Perhaps the calculation is more about the magnitude of losses versus gains, rather than the nominal number of stocks up or down. So, I looked at the actual DJIA components, and how their performance today factored into the calculation of the index.
First the nominal question. Among the Dow 30 stocks, were more up than down? Like the market composite, the answer was no. Out of the 30 stocks, 12 were up and 18 were down.
In fact, the more I looked, the less sense it made that the index finished in positive territory today. Using the percent change for all thirty stocks, I calculated the following:
· The average of the percent change for all thirty stocks is -0.67%. That’s negative two thirds of a percent.
· The median of the thirty numbers is -0.48%.
· The average of the top five gainers 1.74%, while the average of the top five losers is -4.40%
· The average of the smallest five gainers is 0.28%, while the average of the smallest five losers is-0.39%. This was just in case the big gains and losses created outliers that skewed the numbers.
Every way I look at it, the numbers tell me that the market was negative today. In fact, it tells me that the thirty stocks hand picked by the Dow Jones people were negative today.
Yet, there it is: +3.03 points.
The problem lies in the calculation. The DJIA is the only major index that is price weighted. You add up the closing price of all thirty stocks, and divide the sum by a divisor that has been recalculated over the years based on stock splits, stock dividends, and reconstitution of the index. Currently the divisor is 0.1255527090. It does have simplicity on its side.
As a result, Microsoft, trading around $18 per share, counts for 1.9% of the index movement. But at $161 billion, accounts for 6.5% of the collective market cap of the thirty companies. IBM, on the other hand, trading at a whopping $91.50, makes up 9.6% of the DJIA price movement, but with a market cap of $122 billion, less than 5% of the market cap. Microsoft is 32% bigger than IBM, yet IBM counts five times more than Microsoft in the calculation of the DJIA.
Admittedly, there is no perfect index. In my opinion, the Russell 3000 is a superior index. It measures the performance of 3,000 companies, which represents over 95% of the U.S. equity market capitalization. It is cap weighted, and reconstituted annually. However, this isn’t a commercial for the Russell 3000. If you prefer, watch the S&P 500 or the Wilshire 5000.
While the DJIA flirts with its November low, the Russell 3000, even today, is 6.45% above its lows in November.
The real problem is that the investing public continues to listen to the media as it reports on “the market” and gives the closing price of the DJIA.
*All data obtained from Yahoo! Finance
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