If you pay any attention to US financial markets, you can't avoid the Dow Jones Industrial Average (DJIA). It's cited every single day as one of the THE barometers of our financial and economic strength; it runs across the bottom of at least a dozen TV channels throughout the day, and the evening news breathlessly announces every day's changes and celebrates each new record high.
I pretty much ignore it.
How can someone turn their back on THE indicator, THE barometer, THE MOST IMPORTANT NUMBER IN THE ENTIRE WORLD OF PUBLICLY TRADED COMPANIES?
Follow me below the Great Orange Colophon for the answer...
Well, the short answer is that the DJIA has been faked and fudged so many times that I believe it has lost all value as any sort of long-term indicator. At best, it can only be viewed in terms of relatively short increments of a few years - and that has been true for as long as the DJIA has been in existence. Let's take a look...
Dow Jones' own description of the DJIA reads, in part:
The 30 stocks now in the Dow Jones Industrial Average are all major factors in their industries, and their stocks are widely held by individuals and institutional investors.Sounds impressive, comprehensive and downright important, yes? Wait...why is it "stocks now listed"? The answer is simple; the DJIA has been subject to the most basic form of 'gaming the system'--changing the stocks included in the process--since its inception.
The original Dow Jones "average" of 1884 consisted of 11 stocks (9 railroads plus Pacific Mail and Western Union). Within 9 months, however, Jones had to make the first tweaks to his average, to account for the merger of St. Paul Railway into the Chicago, Milwaukee and St. Paul Railroad; he also added 3 more railroads to the mix. These changes didn't last long, however; additional changes were made in 1886 and 1894. Finally, in 1896, the last railroad stocks were removed from the DJIA, and these firms made up the first all-industrial DJIA:
American Cotton Oil American Sugar American Tobacco Chicago GasTo give you a perspective on the numerical DJIA, the first average computed with this group of stocks was 40.94...a far cry from today's 15994.77, eh?
Distilling & Cattle Feeding General Electric Laclede Gas National Lead
North American Tennessee Coal & Iron U.S. Leather pfd. U.S. Rubber
Now, I'll spare you a blow-by-blow of the changes made to the DJIA in its early years; suffice it to say that companies were swapped in and out of the DJIA 33 times between the initial all-industrial list of 1896 and 1939. (The DJIA was left unchanged during WWII.) Let's take a look at the first post-WWII changes to the DJIA, made in 1956:
Allied Chemical American Can American Smelting American Tel. & Tel.This is important, because this was in many ways the benchmark of the 1950s economic boom; US industry was in full swing, and expansion was the rule of the day. Almost all of the DJIA companies, save Sears Roebuck and Woolworth, were directly involved in manufacturing. This would change.
American Tobacco B Bethlehem Steel Chrysler Corn Products Refining
Du Pont Eastman Kodak Company General Electric Company General Foods
General Motors Corporation Goodyear International Harvester International Nickel
International Paper Company Johns-Manville National Distillers National Steel
Procter & Gamble Company Sears Roebuck & Company Standard Oil of California
Standard Oil (N.J.) Texas Company Union Carbide United Aircraft
U.S. Steel Westinghouse Electric Woolworth
It's in the decay of that postwar boom that we see the fudging kick into high gear. Consider the changes made to the DJIA in just the last 30 years or so:
1982: American Express Company replaced Manville Corporation (Johns-Manville).That's a fairly high rate of changes and tweaks to the DJIA "mix"; the end result of all these is the current DJIA:
1985: Philip Morris Companies and McDonald’s Corporation replaced General Foods and American Brands Incorporated (American Tobacco B).
1987: Coca-Cola and Boeing Company replaced Owens-Illinois Glass and Inco.
1991: Caterpillar Incorporated, Walt Disney Company and J.P. Morgan & Company replaced Navistar International Corp., USX Corporation and Primerica Corporation.
1997: Travelers Group, Hewlett-Packard Company, Johnson & Johnson and Wal-Mart Stores Incorporated replaced Westinghouse Electric, Texaco Incorporated, Bethlehem Steel and Woolworth.
1999: Microsoft Corporation, Intel Corporation, SBC Communications and Home Depot Incorporated replaced Chevron Corporation, Goodyear Tire & Rubber Company, Union Carbide Corporation and Sears, Roebuck.
2004: American International Group Incorporated, Pfizer Incorporated and Verizon Communications Incorporated replaced AT&T
Corporation, Eastman Kodak Company and International Paper Company.
2008: Bank of America Corporation and Chevron Corporation replaced Altria Group, Incorporated and Honeywell International, Incorporated.
2008: Kraft Foods Inc. replaced American International Group Inc.
2009: The Travelers Companies, Inc. replaced Citigroup, Inc. and Cisco Systems, Inc. replaced General Motors Corp.
2012: UnitedHealth Group Inc. replaced Kraft Foods Inc.
2013: The Goldman Sachs Group Inc. replaced Bank of America Corp., Visa Inc. replaced Hewlett-Packard Co., and Nike Inc. replaced Alcoa Inc.
3M Company American Express Company AT&T IncorporatedSo, remember when I said that the DJIA wasn't really good for anything other than increments of a few years? Well, here's how long each iteration of the DJIA has lasted in the last 30 years:
Boeing Corporation Caterpillar Incorporated Chevron Corporation
Cisco Systems, Inc. Coca-Cola Company DuPont Exxon Mobil Corporation
General Electric Company Hewlett-Packard Company Intel Corporation
International Business Machines J.P. Morgan Chase & Company Johnson & Johnson
McDonald’s Corporation Merck & Company, Incorporated Microsoft Corporation
Nike Pfizer Incorporated Procter & Gamble Company The Goldman Sachs Group
The Travelers Companies, Inc. United Technologies UnitedHealth Group Inc.
Verizon Company Visa Wal-Mart Stores Incorporated Walt Disney Company
1982-1985: 3 years 1985-1987: 2 yearsAs you can see, we haven't had a consistent selection of firms in the DJIA for a period of more than 6 years in the last three decades. The list has changed 5 times in the last decade alone; how can this kind of turnover/churn create any kind of meaningful long-term statistic?
1987-1991: 4 years 1991-1997: 6 years
1997-1999: 2 years 1999-2004: 5 years
2004-2008: 4 years 2008-2008: 7 MONTHS (AIG removed when the firm tanked)
2008-2009: 1 year 2009-2012: 3 years
2012-2013: 1 year 2013-present: 1 year
Simply put, I do not believe that it can do so. This is especially true when poorly performing companies are simply tossed out and replaced with the current "hot property." It's worth noting that only four companies have been a constant part of the DJIA since 1956: DuPont, General Electric, Standard Oil NJ (now ExxonMobil), and United Aircraft (now United Technologies). Every other spot in the DJIA has turned over at least once...Hewlett-Packard in decline? Bring in Visa! AIG folds? Replace them with Kraft! Wait, Kraft starts to stumble a few years later? Toss them in favor of UnitedHealth! One can even find a few examples of companies fighting their way back into the DJIA after lengthy periods of exile. Coca-Cola and IBM were both added in 1932, but Coca-Cola was tossed in 1935 and wouldn't return until 1987; IBM was dropped in 1937 and didn't make it back until 1979.
What does this history tell us? It's all artificial, folks, going back to when Dow Jones effectively gave up on railroads. The DJIA isn't really worth using for any sort of long-term analysis or comparison. Perhaps the more interesting question is why so much of our attention is directed to that number each and every day...