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February 24, 2009

Overhauling the Dow Jones

I read today about a debate that’s been going on about whether or not the Dow Jones Industrial average should be overhauled to show a more “accurate” picture of the nation’s economy. As far as I can tell, the argument is that since the long established names like GE, GM and Alcoa are all having such a miserable time, the analysts feel as though they may no longer be good indicators of the market as a whole. This may in fact be the case or it may not be, but either way it leads me to think. Is this a “slippery slope”?

One of the reasons that we establish indexes in the first place is so that we have a free-standing measure to gauge things by. The companies that are a part of the DOW are companies that, when you really think about it, represent a broad sector of the greater economy. For instance, in addition to the aforementioned three which are in the electronics, automotive and Aluminum fields, there are banks like B-of-A and Citigroup, the oil and gas companies Chevron and Exxon, technology companies like Microsoft and Intel and miscellaneous food, entertainment and retail companies like Kraft, Disney and Wal-Mart. (You can find the entire listing here). So you can see it pretty much covers all the big components of our economic picture. So here’s the 10 million dollar question (Read: 800 billion dollar question.) Is the Dow outdated, or are we really just that bad off right now?

I submit that I think it's no more logical to “overhaul”, “revamp” or “update” the Dow Jones Industrial average than it is for one of my kids teachers decide to re-define course requirements because too many of the students are failing. (This is something I’ve seen as a matter of fact and thought to be incredibly shortsighted.) The poor performance, whether it is students or economic entities, is not due to the measure being used it is due to some systemic problem that has revealed itself by way of that measure. The grades and the stock ticker numbers are only indices. They don’t make the problem, they only report it. To take away or change the method that the index is pulled from immediately weakens the entire process. How are we supposed to have confidence that the market is really getting better in the future if we know that when it got really bad the powers that be decided to “tweak” the numbers. Who’s to say that in another ten years Google (which is one of the companies being tossed around as a new member of the index) won’t be defunct and irrelevant?

Now I’m no great economic thinker mind you; in fact I’m novice at best. The thing that gets me so spun up about this stuff is that we seem to be continually moving in this direction and with so many things. I don’t know where it can lead us but to ruin. The facts as I see them are irrefutable and constant. We can’t have a gain without a loss like we can’t have light without dark; the higher the gain, the greater the equivalent loss. If you look at the history of our money with respect to the Dow Jones you’ll see something interesting. For the 39 yr period from Jan. 1930 thru Jan. 1969 the Dow rose from 286 to 935, a gain of over 300%. Great right? Now look at the period from Jan. 1969 to Jan. 2007. In that period the Dow soared from that 935 number to 12,354, a gain of over 1300%! How? Did we suddenly have more money? Did we enter a golden age of phenomenal wealth building? Well yeah, kind of, we changed the way we counted our money in 1971 when we completely pulled it off the gold standard. Once that pesky physical limitation was lifted we were only dealing with numbers. Credit use soared, personal savings dwindled and the market went through the roof.

Unfortunately for us, I think we're in the hangover phase right now. The Dow has dropped something like 49% from October 2007. That's 3% per month. So should we change the way we measure it? No, I don't think so. What I do think may be good for us is to really take a hard look at the decisions we make, how we save our money and how we spend it. The Dow is just one of our indicators. It doesn't need to be changed with breezes it just needs to be seen for what it is. Our economy is not healthy right now and there's no reason to change things just to make us feel better, or worse yet to make us complacent enough so that we go out and spend again.

That's about all I have to say on the matter before I start rambling so I'll check out now. Hope you all have a great day tomorrow.


spelled with a K said...

I tend to agree. It is an accurate model of the current concept of business and economic "health." What we need is not an adjustment of who composes "the list." We need to stop relying on something like stock price which can be easily manipulated as one of the key indicators of the economic state of the nation.

ChicagoMike said...

There is a long and distinguished history of changing the measure to make things look better than they are. Reagan redefined poverty and redefined what unemployment was, so if you look at the numbers, things like they were improving at a much better clip than they were. Part of that effort was also the infamous redefinition of ketchup as a vegetable. Not playing politics, its just the most infamous of these sorts of things. Every administration does it somewhere.

Although I can think of a better measure. Use the division of the emploment (SOC code data) to determine employment by percent of economy then choose a cross section of listed companies until you reach a representative amount of employment.

This means that the Dow would reflect employment health.

Just a thought.


Anonymous said...

I do believe the DOW is too narrow to be a good indicator of the overall market, but I don't think the solution is to overhaul it. I just watch the S&P 500 instead.