Distortion in the Dow Jones Index

Jan 26, 2009: 11:51 PM CST

The Big Picture shares an article from James Bianco entitled “The Dow is Distorted” which addresses some recent anomalies in the components in the Dow Jones Index.

Specifically, Bianco argues that the Dow Jones is violating its own ‘unwritten rules’ that any stock that trades less than $10 per share will be excluded from the Dow Index, and at the time of this writing, four stocks traded less than $10:

Citigroup (C): $3.33
General Motors (GM):  $3.38
Bank of America (BAC):  $6.00
Alcoa (AA):  $8.35

These were the stocks and their closing prices as of Monday, January 26, 2009.

Furthermore, Bianco explains how the Dow – as a price-weighted index – changes value.  A $1.00 change in a component’s stock translates to an 8 point move in the Dow Jones Index (7.96 to be exact).   Thus, it wouldn’t matter much if any of these four stocks “went to zero” tomorrow, as it would only create a slight discomfort to the Dow Index.

However, as a price weighted index, stocks whose values are greater can contribute more to the movement of the Dow Jones, such as any of the higher-priced stocks such as IBM ($91.60), Exxon-Mobil XOM ($78.60), or Chevron CVX ($71.29).

Read the article for additional information and ideas.

Despite the fact that the Dow Jones Index is comprised of only 30 stocks, it roughly matches the movements of the S&P 500 Index more than not.  It may be easier to follow (track) the movements of 30 key stocks, but the S&P 500 is expected to be a better barometer of “the market,” particularly as the Dow Jones remains ‘distorted’ by the fall-out of the credit crisis.

Corey Rosenbloom
Afraid to Trade.com

A hat-tip to blog reader Vijay for sending me this article to read.

7 Comments

7 Responses to “Distortion in the Dow Jones Index”

  1. Gawed Says:

    very interesting, one of those things that you rarely stop to think about.
    so actually right now the DOW is guided by Tech and Energy stocks rather than Finnies uh?

  2. Corey Rosenbloom Says:

    That’s right. And no autos either. I’ve always liked the Dow because with 30 carefully selected stocks that represent major industries, it’s equivocated the movement of the S&P, an index of 500 stocks.

    However, the Credit Crisis is skewing the reality of the Dow such that a move in oil prices will swing CVX and XOM in tandem while a major move down in financials will now be muted.

  3. MarshalN Says:

    GE is also getting very close to $10. Can you imagine the Dow without GE?

    BTW, I think you listed FOUR stocks under $10, not three.

  4. Corey Rosenbloom Says:

    Marshal,

    Or without any of those stocks. Bianco said they’re keeping them in there for political and PR reasons – for exactly that. “GE, GM, BAC, C, and AA removed from the Dow today. Panic ensues.” That would be a terrible headline.

    And thank you for catching that. It reminds me that, like a gremlin, I should not blog after midnight because bad mistakes can happen.

  5. droys Says:

    DOW Jones is one of the best for me not only on the quality of their services but also their terrible capability.

  6. kim palma Says:

    DOW rules! they really continue to show how great and trusted they are, their really good on what they do. Continue the good work.

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