Want to annoy an investing pedant? Just talk about U.S. stocks in terms of the Dow Jones Industrial Average.
While the pros vastly prefer more sophisticated indexes weighted by market value over the Dow’s clunky price formula dating to the pre-calculator 1890s, everyone knows it was a bad day when “the market fell 300 points.” Telling your neighbor the drop in the S&P 500 or Russell 2000 is like describing the weather in Celsius.
But the Dow’s other shortcoming—or, depending on how you look at it, strength—is that it reflects human bias. That negates one of the advantages of indexing over active management. Even the S&P 500 is subject to a committee’s whims, but the regular reshuffling of the 30-member Dow affects it a lot more. (Both are published by S&P Dow Jones Indices. Dow Jones & Co. no longer has an ownership stake, but editors of The Wall Street Journal are on the committee that picks Dow stocks.)
True, only a handful of index funds use the Dow as their basis, but membership confers “blue chip” status that impresses some individual stock investors. Others can profit by challenging that conventional wisdom. When the index was last shaken up in the summer of 2020, for example, Covid-19 had turned the world upside down during the past six months. Energy demand plunged and oil futures prices briefly turned negative that spring. And while there was still no vaccine, coronavirus cases had mercifully receded—at least prior to a vicious second wave—and tech stocks were on an epic tear. Reflecting these perceived changes in the economy, energy giant
Mobil was booted out in favor of cloud software company
old school drug giant
was ditched for biotech
and defense contractor Raytheon was swapped for diversified technology firm
Fast forward a bit and oil had rebounded sharply, Pfizer unveiled a lifesaving vaccine and subsequent antiviral Covid treatment and Russia invaded Ukraine, igniting demand for modern weaponry. Meanwhile, tech valuations eventually succumbed to gravity. An investment split evenly between the three Dow exiles would have more than doubled in value including dividends since they were removed to now, while the same investment in the three newcomers would have lost money.
While many historic members of the index are defunct or have since been absorbed into successor companies, the ejection of a dowdy stalwart has been a contrarian buying signal at other times, too. After aluminum company
saw its lengthy Dow tenure end in 2013 for no longer being representative of the U.S. economy, it delivered a return 10 times that of the index it had left over the following year.
Past deletions or tweaks have even affected what we think of as the long-run return of the stock market as measured by the benchmark. For example,
International Business Machines
was removed in 1939 to make room for
and restored in 1979 to replace ailing Chrysler. The Dow rose from 151.1 to 841.98 during those 40 years but, had IBM not been replaced, the index in 1979 would have been 23,582, according to Global Financial Data—a level it didn’t crack until 2017.
Or take current constituent
added back in 2015. It was the largest weight in the index by the summer of 2020, over which time its shares had a total return of 325%. The Dow would have been weaker without it. The summer 2020 reshuffle reduced its weight following a four-for-one stock split and it is now the 16th-biggest constituent.
Since the reshuffling, Apple has merely kept up with the rest of the Dow, but is still the largest member of the S&P 500 that investing snobs prefer.
Write to Spencer Jakab at [email protected]
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