Dow Jones Rocks 40,000

When I entered the investment industry upon graduating from college in 1995, the market was hitting all-new highs. The Dow Jones Industrial Average (DJIA), which everyone seemed to pay attention to, had just broken through 4,000 and would hit 5,000 by the end of the year.

When the DJIA crossed 10,000 for the first time in 1999, there were tons of photos of traders on the floor of the NYSE wearing hats that simply said 10k. In the years leading up to the 10k threshold, one of the popular phrases was 10k by 2000, which it managed to do.

I didn’t know much about indexes at the time, but when we started Acropolis, I learned that the DJIA is a little silly. For one thing, it only has 30 stocks, so it barely represents ‘the market’.

Moreover, it’s a price-weighted index, which means that you add up the stock prices for each company in the index and then divide by the number of stocks in the index.

When Charles Dow first created the index in 1896 for the Wall Street Journal, it made sense because there weren’t many stocks, and it was an easy way to capture what happened in the market. In those days, the index included 12 stocks, including our own Laclede Gas (now Spire).

It was also pretty industrial, with companies like American Cotton Oil Co., US Leather Co., US Rubber Co., National Lead Co., American Tobacco Co., and General Electric (there was not much in the way of branding in those days).

Price-weighting produces an odd effect because the market price is somewhat random. Let’s take Amazon and Ralph Lauren, which are nearly the largest and smallest stocks in the S&P 500 (I picked them for their brand recognition).

Amazon has a price of ~185 per share, and Ralph Lauren has a price of 167 per share. If we made a price-weighted index of these two stocks, it would have a value of 176, and the market movements of each stock would have relatively similar effects on the index.

It’s a little silly, though, because Amazon has a market value (or market capitalization) of $1.9 trillion, and Ralph Lauren has a market value of $10.7 billion. In other words, Amazon is about 190 times larger than Ralph Lauren.

In a market-cap index, Amazon is much more weighted than Ralph Lauren. Amazon is about 3.8 percent of the S&P 500, and Ralph Lauren is 0.02 percent, reflecting the vast size difference between the two companies.

Despite having only 30 stocks, having a price-weighting, and notoriously bad timing by the committee that adds and subtracts stocks to the DJIA, its performance versus the S&P 500 is remarkably close.

I pulled data back to 1964, and the DJIA earned 10.24 percent during that time (through the end of April). The S&P 500 made 10.35 percent during that time, which is the same in statistical terms. The volatility for the DJIA was a little lower, but not by much.

I used to bash the DJIA more, but with such a similar performance, I don’t go too crazy with that anymore. I still think it would be a crazy way to invest, though, partly for the reasons I mentioned but partly because it’s ultra-concentrated.

I’ve written recently that the S&P 500 is unusually concentrated, with nearly a third of the value in the ten largest stocks. That’s downright conservative to the DJIA because the top ten stocks represent 60.5 percent of the value!

Even though it doesn’t mean much, I like seeing the DJIA cross 40k. It makes me wonder if I will see it cross 500k in my lifetime. It’s already a ten-bagger since I started working, and it closed at 1,004.21 on the day I was born.

As crazy as it sounds, if it grows by the same rate and I make it another 30 years, I could see 700k! I’m going to get a hat!