Thursday March 7, 2013
The Dow – old, yes, but hardly irrelevant in march to record
NEW YORK: ,Market professionals sometimes deride it as a relic, deeply flawed in its structure, useful mostly as the man-on-the-street's window on the stock market.
But the old man of Wall Street, the Dow Jones industrial average, has had enough kick left in its 117-year-old legs to vault to an all-time high before its major rivals. Not only that, but it has done it with arguably more tortoises than hares in its mix.
The index hit a high of 14,286.37 on Tuesday, surpassing the previous high set in 2007.
The Dow, created in 1896 with the shares of 12 companies, comprises 30 stocks. Most are household names: General Electric, Coca-Cola, Boeing, Procter & Gamble and IBM.
When it was originally conceived, the index was made up of the more important companies of the time, mainly railroads and raw materials producers. As time passed, the average shifted to reflect the changing economic makeup and now includes only a handful of companies that would be considered “industrial.”
Investment pros regard a clutch of rival market measures the S&P 500, the Russell averages and the MSCI Indexes as better barometers of the overall market because they represent a broader swath of companies. But the Dow remains the common man's index, its compact size and infrequent changes making it easy for the average investor to follow.
The fact that the Dow is so widely followed and recognised by Main Street is part of what makes the index important.
“For everyday investors, the Dow is probably more important than the S&P 500,” said Michael Sheldon, chief market strategist at RDM Financial, Westport, Connecticut.
“The idea that the Dow Jones industrial index is an industrial average reflecting the manufacturing sector in the United States went away decades ago.”
So what has propelled it to uncharted territory when broader benchmarks are still retracing losses from the financial crisis? In a nutshell: dividends and value.
First, most of the stocks in the average pay dividends, giving it a slightly higher dividend yield, currently 2.61%, than the Standard & Poor's 500 Index' yield of 2.52%. The Dow's dividend yield has averaged a quarter percentage point above the S&P 500's yield since the US stock market's post-crisis low in March 2009, attracting investors who favour income as well as stock price appreciation.
From the previous US market peak close on Oct 9, 2007, the Dow's dividend superiority has contributed to a positive total return, including reinvested dividends, of 17.4% versus just 9.9% for the S&P.
Also, during the bear market from October 2007 to March 2009, the Dow fell less than other market measures. For instance, it lost 53.8% of its value, compared with 56.8% for the S&P 500.
The heavy focus on value stocks in the Dow has helped it during the recent market advance that began in November. The blue-chip index sports a price-to-earnings ratio of 14.5 times trailing 12-month earnings while the S&P is about 8% pricier, with a comparable multiple of 15.7.
That value bias has provided a tailwind for the Dow in recent months, with the index up 8.9% so far this year. A broader measure of the market, the Russell 3000 value index is up nearly 9.4% for the year, compared with a gain of about 7.3% for Russell's growth index, and value has outperformed significantly since September.
“Historically, the Dow tends to perform better in difficult markets and the S&P tends to perform better in stronger markets,” said Jamie Farmer, managing director for S&P Dow Jones Indices, in New York.
“If you see the tendency of the Dow right now to outperform slightly, that may be reflection of the fact that people are more drawn to those megacap stocks.”
The Dow has another factor working in its favour over the last few months: it does not include Apple, which has tumbled from its record high hit last September. The stock's huge influence on the S&P 500 has been a significant drag, and had Apple merely remained stagnant after hitting its closing record of US$702.10, the S&P would be about 10 points from its record.
Then again, if Apple had been in the price-weighted Dow over the last several years, it would have overwhelmed the index with its big gains. Apple had not been included in the Dow due to the fact that its still expensive US$425 price would give it an undue influence on the index, said Farmer.
While they might not be the trendiest stocks on Wall Street, companies in the index are seen as having progressed past their heady high growth days and into a more mature stage of life, ideally offering steady returns.
That's not to say the index does not have detractors. The Dow indexes have traditionally favoured stocks that reflect the economic makeup of the economy, so underperformers like American International Group can stay in the index, dragging the average lower. One of the more recent culprits has been Hewlett-Packard, which ironically is the biggest gainer in the Dow this year, up more than 40%.
One or two stocks can play an outsized role in the average's moves because of their price International Business Machines, for instance, at US$200 a share, more than doubles the price of every other member of the average except for two. The S&P 500 and most other indexes, in contrast, are market-cap weighted.
Also, very few stocks in the index can be called “growth” stocks not even tech names like Cisco and Microsoft, which were added after their highest-growth years.
“Obviously it's only 30 stocks, so it's not the broader indicator like the S&P 500,” said Peter Cardillo, chief market economist at Rockwell Global Capital in New York.
“You can have the Dow go up, and rest of the market just flag. It doesn't give you an accurate picture of what the whole market in general is really doing. But it's not something you totally discard.” Reuters