A Closer Look At The Dow
Have you ever seen the majority of your watch list is red, yet the indices are flat or even green? You’re not going crazy, the indices can do a really poor job representing what is actually happening with the majority of individual stocks.
The most widely quoted index- the Dow Jones Industrial Average- is the biggest offender of distorting the action. Unlike traditional market cap weighted indices, the Dow weighs the individual components by price.
So what exactly is it distorting?
After making a new all-time high on August 26th, we have seen the Dow basically trade sideways for the past twelve sessions. You’ll hear people say that we are either stalling out before a correction, or digesting the recent gains before we break out of this range. Whatever your opinion, here are the facts: Currently, the Dow is just 1% from the all-time high, however, if we take a closer peek under the hood, we find that the average Dow component is actually 5.2% off their high.
A closer examination shows that the top three weightings in the Dow (Visa, IBM, and Goldman Sachs) make up 22% of the index, yet represent just 8% of the total market capitalization. Furthermore, the top ten Dow stocks make up ~52% of the index, although they only represent ~36% of the total market cap.
The most over-weight stock in the Dow is Visa, which is awarded an 8.1% weighting although its market cap is only 2.8% of the index. The most under-weight stock is Microsoft, which is just 1.8% of the index, although it represents almost 8% of the total capitalization. To put this in some context, Microsoft is a bigger part of the S&P 500 than it is of the Dow 30, pretty amazing.
So next time you hear that the Dow was up/down by “X” points, understand that it is heavily influenced by a few companies and is not a fair representation of the broader market.