Dow Goes From Strength To Strength

The Dow Jones Industrial Average (Dow) has just passed the 13,000.00 mark for the first time in its history.  This represents an increase of a little over 31,753% from its starting position of 40.94 on 26 May 1896 – equivalent to an annual return of around 9%.  Despite being the oldest and most frequently quoted indicator of US stockmarket growth, many people probably aren‘t aware that the Dow is in many ways a rather peculiar index.

Unlike many other indices, the Dow is measured based on a ‘price-weighted average‘; this means that a $1.00 change in the share price of one company has the same effect on the index as a $1.00 change of the price of another, even though one of the companies might be five times larger than the other.  The FTSE 100 Index, the most widely quoted share index in the UK, for example, is calculated on a ‘market-value weighted‘ basis; meaning that the movement in the share price of a large company like Vodafone, will have a more marked affect on the value of the index than a smaller company like Marks & Spencer, which is nearly 10 times smaller than Vodafone by market capitalisation.  Consequently, it is often argued that the Dow is not the best indicator of US market performance.

Furthermore, the Dow only comprises 30 companies, representing the largest and most widely held public companies.  For a better gauge of the US market, the S&P500 is seen as a more accurate indicator.  The S&P500 is calculated in the same way as the FTSE 100 Index and represents the 500 largest US quoted public companies by market capitalisation.  At the moment, for example, although the Dow is at an all time high, the S&P500 is about 2.0% lower than it‘s highest point in March 2000 and S&P believe that if the Dow was calculated in the same way as the S&P500, it would be about 12% lower.

Over time, however, many analysts agree that the Dow and S&P500 correlate quite well and that although the S&P500 is undoubtedly a superior measure of the US stockmarket, the Dow is likely to remain the most quoted index for the foreseeable future.