The Human Index
Author: Geoff Gannon
Author: Geoff Gannon
As the Dow approaches a new all-time high (the record close was
11,722.98), now would be a good time to take a break from the
financial news found on your televisions, in your newspapers,
(and yes) even on your computers.
A new high is an empty headline. I'm not writing to tell you
that; you already know that. What you may not fully appreciate
is just how arbitrary an index the Dow Jones Industrial Average
really is.
Most notably, it's no longer very industrial. Only about one of
every three stocks in the Dow is involved in what might be
considered an old-line industrial (heavy manufacturing,
extraction, etc.) business. A lot of the Dow components are
involved in totally different businesses such as consumer
products, health care, and technology. For the most part, these
businesses are usually a lot less tangible. The businesses are
asset-light; the future prospects are largely company specific.
Today, the extent to which the common stocks of the thirty
companies move together may have more to do with their shared
classification as "Dow" stocks than with the future prospects
of the underlying businesses.
On April 8, 2004 some changes were made to the Dow. These
weren't the first changes – and they won't be the last. Such
changes add to the arbitrary nature of the index, especially in
the short-term.
Generally, the changes have been motivated more by who should
go than with who should come in. Discarded Dow components can
usually blame a dying industry for their exit. Sometimes, a
rapidly dwindling market cap helped.
The April 2004 changes involved three spots in the index and
six stocks.
Departures: AT&T (T), Eastman Kodak (EK), and International
Paper (IP).
Arrivals: Verizon (VZ), American International Group (AIG), and
Pfizer (PFE).
Please note that AT&T is now back in the Dow. In November 2005,
SBC Communications, which was itself born from the 1984
divestiture agreement between AT&T and the Justice Department,
changed its name to AT&T after acquiring that company. It also
adopted the ticker symbol associated with that name (T). As a
result, a chart of the new AT&T does not reflect the fortunes
of the old AT&T.
None of these stocks has fared particularly well. In fact,
since the changes, they've all basically underperformed the S&P
500. With the exception of Kodak (and Verizon for a very short
time), none of the stocks have managed to trade above the share
price they had at the time of the reshuffle
Is this just a coincidence?
As a rule, reshuffling an index through human intervention is
likely to produce odd (and unexpected) coincidences.
The Dow is made up of a small number of companies. These
companies tend to be very high-profile businesses. They are
also high-profile stocks. Usually, they were high-profile
stocks before they entered; but, obviously, being added to the
Dow only increases investor interest in their fortunes. Any
human intervention is likely to reflect the (current) biases of
investors (and the financial media).
The result? A very human index.
About The Author: Geoff Gannon writes a daily value investing
blog and produces a weekly (half hour) value investing podcast
at: http://www.gannononinvesting.com
11,722.98), now would be a good time to take a break from the
financial news found on your televisions, in your newspapers,
(and yes) even on your computers.
A new high is an empty headline. I'm not writing to tell you
that; you already know that. What you may not fully appreciate
is just how arbitrary an index the Dow Jones Industrial Average
really is.
Most notably, it's no longer very industrial. Only about one of
every three stocks in the Dow is involved in what might be
considered an old-line industrial (heavy manufacturing,
extraction, etc.) business. A lot of the Dow components are
involved in totally different businesses such as consumer
products, health care, and technology. For the most part, these
businesses are usually a lot less tangible. The businesses are
asset-light; the future prospects are largely company specific.
Today, the extent to which the common stocks of the thirty
companies move together may have more to do with their shared
classification as "Dow" stocks than with the future prospects
of the underlying businesses.
On April 8, 2004 some changes were made to the Dow. These
weren't the first changes – and they won't be the last. Such
changes add to the arbitrary nature of the index, especially in
the short-term.
Generally, the changes have been motivated more by who should
go than with who should come in. Discarded Dow components can
usually blame a dying industry for their exit. Sometimes, a
rapidly dwindling market cap helped.
The April 2004 changes involved three spots in the index and
six stocks.
Departures: AT&T (T), Eastman Kodak (EK), and International
Paper (IP).
Arrivals: Verizon (VZ), American International Group (AIG), and
Pfizer (PFE).
Please note that AT&T is now back in the Dow. In November 2005,
SBC Communications, which was itself born from the 1984
divestiture agreement between AT&T and the Justice Department,
changed its name to AT&T after acquiring that company. It also
adopted the ticker symbol associated with that name (T). As a
result, a chart of the new AT&T does not reflect the fortunes
of the old AT&T.
None of these stocks has fared particularly well. In fact,
since the changes, they've all basically underperformed the S&P
500. With the exception of Kodak (and Verizon for a very short
time), none of the stocks have managed to trade above the share
price they had at the time of the reshuffle
Is this just a coincidence?
As a rule, reshuffling an index through human intervention is
likely to produce odd (and unexpected) coincidences.
The Dow is made up of a small number of companies. These
companies tend to be very high-profile businesses. They are
also high-profile stocks. Usually, they were high-profile
stocks before they entered; but, obviously, being added to the
Dow only increases investor interest in their fortunes. Any
human intervention is likely to reflect the (current) biases of
investors (and the financial media).
The result? A very human index.
About The Author: Geoff Gannon writes a daily value investing
blog and produces a weekly (half hour) value investing podcast
at: http://www.gannononinvesting.com
