Photo: Funny or Die
Something unusual happened today.The Dow Jones Industrial Average climbed 0.6 per cent, the S&P 500 was flat, and the Nasdaq Composite fell 0.8 per cent.
Why the discrepancy?
Neither Apple nor Google are in the Dow.
A lot of people talk crap about the Dow because of these exclusions. They argue that the Dow should be more like the S&P 500.
But that’s a bit narrow-minded.
Why Everyone Hates The Dow
The case against the Dow is pretty straightforward. It is biased because it’s a price-weighted (not market-cap-weighted) index of just 30 stocks, which are more or less picked arbitrarily.
“Price-weighted” means that stocks with the highest share prices have the most influence on the index’s movements. So, McDonald’s, which has a market cap of $98 billion and share price of $97, would have a larger impact on the Dow than ExxonMobil, which has a market cap of $395 billion and share price of $84.
So, the price-weighting bias is clear and pretty valid.
Regarding the selection process, here’s what Bloomberg Businessweek’s Roben Farzad recently had to say:
So maybe this embarrassing, ongoing snub of Cupertino is less about Apple and more about the creeping obsolescence of the world’s most-quoted stock index.
According to research cited by Farzad at the time, a Dow that included Apple would be around 2,000 points higher.
It’s as if the goal of indices, according to Farzad, is to be as high as possible.
Let’s Be Clear, The S&P 500 Isn’t Perfect Either
We won’t argue the claim that the Dow is less robust than the S&P 500. However, the S&P 500 is not without its biases either.
The S&P 500 is a market cap-weighted index. The obvious bias is that the largest market cap companies have the most influence on the index’s. But large companies tend to be mature or overvalued.
In other words, the S&P is basically the story of what Apple and ExxonMobil is doing.
The World Is Big Enough For A Dow, An S&P 500 And A Nasdaq
We’re not trying to argue that one index is better than the other or that there should be one all-encompassing type of index.
Rather, we think that each type of index has something valuable to offer. By understanding the biases of each index, one can get a more accurate and comprehensive read on the markets and the economy by looking at all three side-by-side.
This is particularly true when the indices diverge.
Today, if we only heard the S&P 500 fell, then we probably would’ve concluded that most stocks fell. In reality over half of the index actually rose.
Furthermore, by knowing that the Nasdaq underperformed and the Dow actually rose, you could then reasonably conclude that tech stocks, especially those that aren’t in the Dow, were the real losers today.
It’s the differences in the indices that cause the divergences, and that in turn is what makes them great.
One More Thing
If you still think the Dow is worthless, then maybe this video from Funny or Die will change your mind:
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