Bailout

The silly, underperforming Dow

By Felix Salmon

Eddy Elfenbein notes that the Dow has significantly underperformed the market of late. Here’s how it compares to the S&P 500 over the past 180 days: up 16.6%, which is great, but not nearly as great as the S&P’s 19.9% gain.

Is this a bearish sign of speculative activity? Perhaps; Eddy’s theory is that “the Dow hasn?t captured the strength in cyclical stocks.” But the big picture, of course, is that the Dow is a ridiculous way of measuring the stock market, and that it’s certain to diverge from the S&P 500 on an irregular basis. The real surprise, frankly, is not that it diverges as much as this now and then, but rather that it hews so closely to the broader stock market most of the time.

One thing worth noting here is that two of the top five companies in the US, by market capitalization, are essentially disqualified from being part of the Dow: Apple is over $300 a share and Google is over $600 per share, which makes it impossible for either of them to enter a price-weighted index. Google has 1.38 times the weighting of Bank of America in the S&P 500; if it entered the Dow, it would have more than 43 times BofA’s weighting.

I do wonder what it is about the Dow which keeps it alive in the popular imagination and the financial media. I think it might have something to do with having an index level in the thousands: it’s like video-game scores, which always add a few zeroes just to feel more impressive. The S&P 500 should probably have been set to 500 rather than 44 at inception in 1957: then there would be no need for the silly Dow at all.

Full post as published by Macroprudential on January 07, 2011 (boomark / email).