Bianco: The Dow is Distorted
January 21, 2009 James A. Bianco, CEO of Bianco Research, LLC

Comment – The Dow Jones Industrial Average (DJIA) is a price weighted index. The divisor for the DJIA is 7.964782. That means that every $1 a DJIA stock loses, the index loses 7.96 points, regardless of the company’s market capitalization.

Dow Jones, the keeper of the DJIA, has an unwritten rule that any DJIA stock that gets below $10 gets tossed out. As of last night’s close (January 20), The DJIA had the following stocks less than $10…

Citi (C) = $2.80
GM (GM) = $3.50
B of A (BAC) = $5.10
Alcoa (AA) = $8.35

If all four of these stocks went to zero on today’s open, the DJIA would lose only 157.3 points.

The financials in the DJIA are…

Citi (C) = $2.80
B of A (BAC) = $5.10
Amex (AXP) = 15.60
JP Morgan (JPM) = $18.09

If every financial stock in the DJIA went to zero on today’s open, it would only lose 331.25 points, less than it lost yesterday (332.13 points).

If you want to add GE into the financial sector, a debatable proposition, then:

GE (GE) = $12.93

If the four financial stocks above and GE opened at zero today, the DJIA would only lose 434.24 points.

The reason the DJIA is outperforming on the downside is the index committee is not doing it job and replacing sub-$10 stocks and the financials are so beaten up that they cannot push the index much lower.

So what is driving the index? The highest priced stocks:

IBM (IBM) = $81.98
Exxon (XOM) = $76.29
Chevron (CHV) = $68.31
P&G (PG) = $57.34
McDonalds (MCD) = $57.07
J&J (JNJ) = $56.75
3M (MMM) = $53.92
Wal-Mart (WMT) = $50.56

For instance if all the sub-$10 stocks listed above, all the financials listed above and GE opened at zero, the DJIA loses 528.63 points. To repeat if C, BAC, GM, AA, JPM, AXP and GE all open at zero, the DJIA loses 528.63 points.

If IBM opens at zero, it loses 652.95 points. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE and Alcoa combined.

The DJIA is not normal as the Index committee is not doing their job during this crisis, possibly because of the political fallout of kicking out a Citi or GM. As a result, this index is now severely distorted as it has a tiny weighting in financials and autos.

We thank Jim Bianco for giving us permission to share his firm’s research with our readers.
James Bianco, Chief Executive Officer, Bianco Research, LLC

Category: BP Cafe, Data Analysis, Index/ETFs

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

7 Responses to “Bianco: The Dow is Distorted”

  1. zachstocks says:

    Very interesting observation. This means that a 7.5% move in IBM is just as important as BOTH Citi and GM going out of business.

    At the same time if many of the low price companies DOUBLE it has little effect on the average.

    Another good reason to not like price weighted indices (or maybe a good reason for the committee to stay on top of its game)

    Zach

  2. Mr.Sparkle says:

    Echo the above sentiment.

    I’ve long tracked this via Excel and noticed this phenomenon back when GM and AIG had their woes. I even put up a little table of the DJI component weights a week ago to illustrate the problems with the DJI weighting system. It becomes even more obvious today when a company like CAT releases bad earnings and drops the index more than BAC and C both being down by far larger margins. And CAT is as close to an “average” weight DJI component as you can get at about 3.2%.

  3. dunnage says:

    I have a question. Be happy to blame a committee, in this case the Index committee, cause it’s a bunch of folks and committee has Ms and Ts and Es galore making me feel as thought I were actually proficient at typing.

    But — as you then do as they should of done — tell me your picks to replace Citi, GM, BAC in the Dow restoring the proper weightings in financials and autos?

  4. dunnage says:

    Hey, how about Wachovia and Studebaker?

  5. cognos says:

    This is a really excellent post.

    Now for the last time Grandpa, lets start talking S&P500.

    Just think of it like the Dow divided by 10.

  6. KidDynamite says:

    good post – and you didn’t even mention how absolutely absurd it is to have a price weighted index in the first place…

    it seems like it shouldn’t be that hard to convince the monkeys on CNBC that the DOW is irrelevant

  7. jonathanikatz says:

    All the criticism of the Dow is valid. But the S&P500 and NYSE indices track it very closely. Empriically, it works.