DJIA: Don't Reshuffle Index, Just Cease The Index (GE, MMM, AA, GM, C, BAC, AIG, HON, DIA, SPY)

The Dow Jones industrial average, or DJIA, is perhaps the mostly widely recognized index in the world.  When people talk about “The Market” in cabs and in bars, and on the phone, they do not really mean the advance/decline line.  They do not mean the S&P 500.  They don’t even mean the tech-heavy NASDAQ.  They mean the stodgy old DJIA.

There has been much discussion about the Dow now that so many of its members are trading are well under $10.00 (and some challenging $1.00).  This may sound like lunacy, but there are many reasons that this long-time market barometer should be killed.

We are realistic that the chances of this happening are probably slim to none, and Slim left town.  There are actually no secrets here.  But there are also many issues which are widely known.  It is true that most index weightings are based on a company’s market capitalization, but not the DJIA.  It is a price-weighted index, so its value and member weighting is based upon share prices of each component rather than the market cap.  The S&P and the NASDAQ-100 are weighted based upon the market caps of each stock.  So let’s show some samples.

Even when General Electric (NYSE: GE) was a $30.00 stock, its weighting was just average despite its mega-cap status.  But now with a price under $7.00, its weighting is significantly lower than another conglomerate 3M (NYSE: MMM). GE’s $70 billion market cap is trumped because 3M has a share price that is more than 6-times of GE even though the parent of NBC has more than twice the market value.  We have not heard that GE  is at risk of being booted out of the DJIA.  But many other low-priced stocks may be in danger.

What about Alcoa (NYSE: AA) since it is now a $5.00+ stock?  General Motors Corporation (NYSE: GM) might be next nn the $1.00 club.  Its shares were down 15% at $1.86 after that dreaded “going concern” issue came up in its annual report.  It doesn’t matter that the company tried to defend itself.

Citigroup, Inc. (NYSE: C) broke the $1.00 barrier.  That is a first.  And are we really supposed to believe it isn’t government-owned?  This is going to be the next one booted from the DJIA if this keeps up.   Bank of America (NYSE: BAC) has repeatedly said that it is financially sound.  Yet, this fairly recent addition to the DJIA is now only a $3.00+ stock.  We haven’t heard it being at-risk, but at $3.00 and with sellers in total control you have to wonder.  A recent boot from the index was American International Group (NYSE: AIG).  Imagine if the DJIA kept it in?  And Honeywell International Inc. (NYSE: HON) was booted a while back, and you can bet the DJIA wishes it kept it in the index with it “only” about 60% off of highs.

Active traders have already been using the Standard & Poor’s 500 Index as “The Market” for some time.  It also has many stocks now having fallen out of favor with very low share prices.  But it at least has a more fair calculation of index values.  It is also less affected by the subtraction or addition of a high-priced or low-priced stock from the index.  And even the key ETFs back this up:

• The DJIA ETF is the DIAMONDS Trust (NYSE: DIA) with a 30.2 million share volume per day.
• The S&P 500 ETS is the Spyders, or the SPDRs (NYSE: SPY), with an average daily volume of more than 300 million shares.

We do not expect that this index will be disbanded.  History might be enough to keep it alive.  But there is money behind it too for Dow Jones, a unit of News Corp.  McGraw Hill owns the S&P indexes.  The first index we look at is the S&P 500 Index.  The DJIA 30 is just no longer representative of “The Market” except for the fact that it goes down every day.

Jon C. Ogg
March 5, 2009