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Or, conversely, "How can I be down when the market is rising?" Customers have asked me both questions and the answer is the same for each:
"There is no" The market "for stocks."
From the perspective of an American investor, there are three benchmarks that give a partial picture of what stocks are doing, but that's just that – a partial picture. And this doesn't even take into account the myriad of other indexes from other countries and regions.
For US investments, the first of these is the venerable old one (DJIA, DJI or "The Dow.") When someone asks, "How's the market?" or a TV presenter reading his teleprompter says, "Today the market ended on xyz," the Dow is the index they usually talk about. Which is strange, since it is the least scientific of all indexes …
Why am I saying this? First of all, the DJI is made up of just 30 US companies out of the thousands that are traded on the various exchanges and around the world. There are about 3,500 stocks listed on US stock exchanges (and about 630,000 companies traded in total over-the-counter or in other parts of the world). Using only the US-listed companies, the DJIA represents less than 1% of all of these disparate companies.
Yes, they are big "blue chip" companies, yet 1% does not give a particularly accurate picture of what your portfolio is likely to do on any given day (unless of course your only stock is the DJIA ETF or some other fund.
Is this index really representative of your portfolio?
It gets worse. The Dow is "price weighted" rather than market capitalization ("market cap") weighted, so "dollar" move is more important than a percentage move up or down. In other words, the most expensive stocks in the index pull the & # 39; average & # 39; more skewed than the cheaper stocks under 30.
Finally, the selection of subjects that make up the Dow seems arbitrary and borders on capricious. A committee meets every now and then to decide whether, in their opinion, the current 30 companies best represent what is happening in the wider investment landscape. Then the DJI components remain the same. If not, take their heads off and the committee will replace them with another company.
From 2013 to 2020, nine companies have been replaced by nine others. That means that "the Dow" of today is not the same as the Dow of 7 years ago – 30% of the positions in it are new!
Why is this important? Since the DJI is still the most cited market benchmark, it has a greater share of the mind for the average investor who doesn't have time to monitor the market hour by hour.
Let's take a closer look at these changes. In 2013, Alcoa (NYSE :), Bank of America (NYSE 🙂 and Hewlett-Packard (NYSE 🙂 were replaced by Goldman Sachs (NYSE :), Nike (NYSE 🙂 and Visa (NYSE :). Good timing. Since then, the last three have fared much better than the first three.
In 2015, AT&T (NYSE 🙂 was removed from the DJI and replaced by Apple (NASDAQ :). That has been a real coup. Apple was booming at that time. (In fact, 25% of the entire increase in the last 10,000 point "increase" in the Dow was due to Apple alone!) This is certainly one case where the one that booted probably just kept slogging on, while Apple is the darling of the Dow and the.
In 2018, General Electric (NYSE 🙂 was dropped and replaced by Walgreens Boots Alliance (NASDAQ :). I'm not a fan of the basket case that GE has become over the years (starting with making 600 acquisitions from success guru Jack Welch, shifting GE into emerging markets and entering into unsustainable long-term care contracts.) However, Walgreen & # 39; s more representative than an industrialist who has his fingers in so many pies?
In 2020, the committee established Exxon Mobil (NYSE :), Pfizer (NYSE 🙂 and Raytheon Technologies (NYSE :). It replaced this 10% of the total number of companies in the benchmark with Salesforce.com (NYSE :), Amgen (NASDAQ 🙂 and Honeywell (NYSE :).
One reason given for this more recent change is Apple's declining influence in the index following Apple's stock split. The committee noted that the Dow needed more technology in its benchmark, so they chose Salesforce.com.
Really? Apple, Cisco (NASDAQ :), IBM (NYSE :), Intel (NASDAQ 🙂 and Microsoft (NASDAQ 🙂 already made up just under 20% of the Dow, even after the split from Apple.
What does the Dow Jones Commission say about this?
"The announced changes help offset that reduction [as a result of Apple’s split.] They also help diversify the index by removing the overlap between companies of similar size and adding new types of companies that better reflect the US economy" . "[Emphasis mine.]
Question here. What "new types of businesses"? Both Amgen and Pfizer are pharmaceutical companies and both Honeywell and Raytheon (NYSE 🙂 are aerospace and defense companies. Salesforce (NYSE 🙂 is tech. So much for new types of businesses.
It is true that times change and replacements must be made. American Car and Foundry, Baldwin Locomotive and American Woolen are no longer with us. Companies go bankrupt or are taken over by other larger companies. This is not the problem.
Fresh blood, bigger price increases
I think the problem is that a lot of index changes are done just to bring in fresh blood, otherwise, more successful companies or securities will be likely to increase in price. The decision to switch companies to an index of 30 companies should not be taken lightly. Are Raytheon, Exxon or Pfizer in danger of going out of business? Maybe someday, but that day is probably a long way off when it happens.
Are these changes made because, for example, Honeywell is more representative of its industry than Raytheon? Is Amgen more representative of the pharmaceutical industry than Pfizer? Or are they just moving better from today? The DJI may be more representative as a result of these changes or not, but it certainly helped climb the index higher than it otherwise would have been. AT&T and Bank of America are still concerned; they just weren't as prone to roaring ahead as Apple and Goldman Sachs. These new additions may be more representative, or they may not, but they have certainly proven to be high-flying.
The two things to understand how the Dow really works are:
We have to remember to ask ourselves "What is the market like?" that the DJI of "x" months or years ago was a very different index than at the current date, and
Since it is price weighted, a movement of those stocks within the Dow with a low market capitalization – but a high share price – could have an effect on the & # 39; Dow & # 39; that is disproportionate to their actual weighting.
As an expensive stock progresses, it adds a huge amount to the DJI increase for the day. However, if a low-priced stock that's held much wider roars ahead, it's a whore. Before Apple's recent 4: 1 split, when Apple shares rallied $ 1 in price, this was reflected as 10 times the move in the Dow than if ExxonMobil had the same upward price change of $ 1 per share.
Wonder if it's a coincidence that Exxon has been dropped from the benchmark? (But since the DJIA has been around for over 100 years, no mortal should criticize its methodology!)
Answering the question "How can I get up when the market is down?" the answer is simple: few of us have the 30 stocks, or even the exact same sectors, as the Dow. But because it is the grandfather of all benchmarks, it gets pole position when people talk about & # 39; The Market & # 39; – clearly a misnomer if there ever was one!
In Part II}} I will discuss a much more representative index, the Standard & Poors 500, which measures the daily movement of 500 US large-cap companies. It may be more representative, but it suffers from many of the same flaws as the Dow. I will also discuss the {{170 | Russell 2000, my own approach to investing using these indexes, and an example from my own portfolio of holdings based roughly on these three indexes.
Disclaimer: Unless you are a Stanford Wealth Management customer, I do not know your personal financial situation. Therefore, I am offering my opinion above for your due diligence and not as advice to buy or sell specific securities.
