Why is so much focus put on the Dow Jones Industrial Average?

Question

The Dow Jones Industrial Average is derived from the sum of the stock prices of 30 large-cap companies, divided by the Dow Divisor which, at the moment is actually a multiplier.

It's mostly NYSE properties, with a handful of NASDAQ companies.

However, the 2,400 companies whose stock are traded on this exchange are mostly nowhere near the share price of the DJIA members. In addition, the DJIA is based on price and doesn't directly factor in the size of the company.

Given how disconnected the DJIA is from the well-being of the vast majority of the NYSE the fact that the success (or otherwise) of large-cap and small-cap companies aren't necessarily in lock step, why is so much focus put on the DJIA as an indicator of the US economy?

To distract from the economic indicators that really matter. — Eric Hauenstein, Dec 21 '20 at 14:32

score 17 · Answer 1 · edited Dec 21 '20 at 18:39

17

I think that you've been sidetracked by a number of factors such as price weighted versus capitalization weighted, the Dow Divisor as a multiplier, and the exchange that the stocks trade on. In addition, if you're interested in a large cap versus small cap comparison then compare indexes representative of those sectors.

The DJIA and other indexes are a reflection of the stock market. They are not are not an indicator of the health of the US economy.

As for why the DJIA is so widely followed, it might be because it's the second oldest US stock market index. It may just be force of habit. Over the past 5, 10 and 20 years, the S&P 500 has outperformed the DJIA or vice versa by less than one percent so despite the DJIA being composed of only 30 stocks, it has been a fairly good indicator of the overall stock market.

edited Dec 21 '20 at 18:39

answered Dec 21 '20 at 00:57

Bob Baerker

76,304
15
99
175

To clarify, SPY is the S&P 500 index, which is the 500 largest companies by market cap, right? – Dancrumb Dec 21 '20 at 18:11
2

The SPDR S&P 500 Trust ETF, also known as the SPY, is one of the most popular funds that aims to track the Standard & Poor's 500 Index, which comprises 500 large- and mid-cap U.S. stocks. – Bob Baerker Dec 21 '20 at 18:17
"They are not are not an indicator of the health of the US economy." That's simply false. https://www.investopedia.com/terms/e/economic_indicator.asp – Acccumulation Dec 21 '20 at 22:33
3

@Acccumulation Investopedia is a website about investing. They define an "economic indicator" as something you use to guide "investment possibilities". As far as it is concerned, it appears the economy is the stock market (plus private ownership of companies and the like)... – Yakk Dec 22 '20 at 03:15
@Yakk From the link "These indicators also help to judge the overall health of an economy." – Acccumulation Dec 22 '20 at 03:27
5

@Acccumulation It isn't an indicator of the health of the US economy however you want to put it. It could be an indicator of the health of the 1% of the 1% maybe but not the US economy. Have a look at what's been going on in 2020. Stock markets (DJIA included) are close to ATH while economic activity is nowhere near 2019 levels. FED prints money and injects it into the stock market which pumps the prices while 10s of millions are unemployed... – Dec 22 '20 at 07:38
There is a correlation between economic activity and equity prices. Over short term periods, the stock market often detaches from economic performance (note the stock market currently at all time highs with an unemployment rate of almost 7%). Corporate profits are a better indicator of the economy's strength. – Bob Baerker Dec 22 '20 at 15:13
1

"The DJIA and other indexes are a reflection of the stock market. They are not are not an indicator of the health of the US economy." - This is 100% true but not widely recognized or understood. Certainly when political figures (and many non-political analysts) talk about a "strong economy" what they really tend to mean is "share prices are generally up". Worth emphasizing the point that share indices do not reflect overall economic health, imo. – aroth Dec 22 '20 at 23:39
1

The DJIA is at all time highs. If it's a reflection of the health of the economy then what is need for Congress to pass a $900 billion pandemic aid package which many believe to be too small? – Bob Baerker Dec 23 '20 at 00:11
Health of the economy: In pandemic America's tent cities, a grim future grows darker. ... in the spring of 2020, federal, state and local governments issued temporary bans on many evictions... Since the pandemic began, more than 162,000 evictions have been filed in 27 cities...So far, Congress has no clear plan to deal with the expiration of the CDC's ban, when up to 40 million people will be at risk of eviction, according to the Aspen Institute – Bob Baerker Dec 23 '20 at 13:45

score 14 · Answer 2 · answered Dec 21 '20 at 12:20

The DJIA is followed by non-investors, and even by investors who are only invested through their 401(k) or a mutual fund in their IRA. It is reported during the quick market updates given on news radio, and local TV news. It is in heavy rotation on the lower third chyron on cable news.

But why? Because it is easy to "understand": going up is good, going down is bad. But there are other US and global indexes that could do the same thing, so why not one of those? 30 stocks are easy to understand. Almost all of them are recognizable to non-investors.

Yes you can explain why others are better indicators, but to most people those are not important reasons. Those are technical reasons that they don't care about. The Dow-Jones Industrial Average is what they know. The biggest reason why they should care about the S&P500 is that the performance of their 401(k) and IRA investments are compared with that index. But still they evaluate health of the economy with the DJIA.

Equating any stock index as an indicator of the US economy is problematic. We are currently in a global pandemic where the unemployment rate is going up, the number of people using food banks is going up, hospitals are full; but the market just hit a new record - therefore the economy is great.

RonJohn · Answer 3 · 2020-12-21T16:00:37.030

8

IMO:

Tradition: people have been following it for a Really Long Time.
Laziness: do media outlets want to put the effort into finding something better.
Practicality: a lot of people are invested in the stock market.

EDIT: 4. "The Dow" is easier to say, and more dramatic, than "the S&P 500" or "the NASDAQ".

edited Dec 21 '20 at 16:00

answered Dec 21 '20 at 00:38

RonJohn

50,666
10
106
170

2

The fact that the DJIA has been used for a really long time explains why it's such a crummy index: it's been used since before reporters had the capability to compute a better index. – Xerxes Dec 21 '20 at 14:48
3
They already have: they regularly report the NASDAQ and S&P500 indexes as well. 3. That explains why indexes are reported, not specifically the DJIA.

Barmar

Dec 21 '20 at 15:21

@Barmar but "the Dow" is given center place. – RonJohn Dec 21 '20 at 15:59

And 2a: Do most news readers/viewers WANT a "better" index, or do they want something they can sort of understand in 5 or 10 seconds of airtime? – jamesqf Dec 21 '20 at 17:24

@jamesqf before that, ask if "most news readers/viewers" know the significance. And whether or not the media uses it for drama. – RonJohn Dec 21 '20 at 19:19

score 3 · Answer 4 · answered Dec 21 '20 at 15:55

The DJIA is the only common stock index composed of stocks that have been carefully chosen to represent the range of industries that make up the economy. Most other indexes are composed of stocks chosen using relatively simple algorithms: the S&P 500 is the top 500 US public companies by market capitalization, the NASDAQ Composite Index is all companies that trade on the NASDAQ exchange.

The 30 companies in the Dow Jones, on the other hand, have been chosen to be most representative of their respective industries. And the composition of this group is changed over time to reflect how important various industries are in the US economy.

While there's some subjectivity to this selection, and even possibly some form of self-fulfilling prophecy (adding a company to the DJIA may attract investors to it), historically the DJIA has correlated pretty well with the market as a whole. And it can be easier to understand why it moves as it does, because there are so few variables involved.

It can be instructive to look at how the composition of the Dow 30 has changed. The current index is heavy in information tehnology (Apple, Microsoft, IBM, Intel, Salesforce, Cisco), financial services (Visa, Goldman Sachs, JPMorgan Chase, AmEx), health care, and retailing (although the retail sector is still all brick&mortar chains -- it can't be too long before Amazon.com joins). Many years go there was a much larger emphasis on industrial machinery and agriculture because those were much more important sectors of the US economy. General Electric was in the index since its inception (over a century), but was replaced in 2018 as they had been struggling to find their place in the 21st century economy, even though they're still an enormous company.

Why is so much focus put on the Dow Jones Industrial Average?

4 Answers4