The Dow Jones is a terrible measure of the U.S. economy
Created by Charles Dow in 1896, the Dow Jones Industrial Average was intended to act as a “proxy for the broader U.S. economy.” Currently, it’s purpose is to provide a big-picture view of whether stock prices are generally moving up, down, or sideways from moment to moment, and by how much.
For the past 126 years, the Dow Jones Industrial Average (DJIA) has served as a barometer of the stock market’s health. The index is composed of 30 highly profitable, multinational companies.
In many respects, the Dow Jones is home to mature and generally slower-growing businesses. Although, “mature” businesses can make patient investors wealthier and long-term investors financially independent.
All components of the DJIA are household names like Johnson & Johnson (JNJ), Coca-Cola (KO), Disney (DIS), and Microsoft (MSFT).
Dow Is Weighted
The DJIA is price-weighted. Rather than using a simple arithmetic average and dividing by the number of stocks in the average, the Dow Divisor is used.
This divisor smooths out the effects of stock splits and dividends. The DJIA, therefore, is affected only by changes in the stock prices, so companies with a higher share price or a more extreme price movement have a greater effect on the Dow.
Many financial pundits argue that the DJIA has lost its relevance as a barometer of U.S. stocks. the Dow is deeply flawed. Professor Jeremy J. Siegel at the Wharton School summed it up. Today, no one would build a stock market index that contains only 30 companies, with some sectors of industry completely excluded (like utilities). Worse, the index is weighted by share price instead of market capitalization, which means one company, Boeing, has a wildly outsized sway on the entire stock market.
Yet, DJIA continues to serve as a market and economic indicator. As long as it contains the stocks of companies that reflect the major industrial areas of the U.S. economy during any given period, this 30-stock index will likely remain the standard of financial indicators.
References:
- https://www.msn.com/en-us/money/savingandinvesting/the-dow-jones-industrial-averages-5-fastest-growing-stocks/ar-AA103dnv
- https://www.investopedia.com/articles/stocks/08/dow-history.asp
- https://www.investopedia.com/ask/answers/difference-between-dow-jones-industrial-average-and-sp-500/