The Dow Jones Is Price Weighted, Giving Certain Components Disproportionate Influence.
The Dow Jones Industrial Average (Dow) is the oldest and most prestigious stock index. It’s methodology of calculation is also one of the strangest. While nearly all indexes are market capitalization weighted, the Dow is “Price” weighted.
Price weighting means that a $30 component will have MUCH LESS impact than a $300 component, regardless of market capitalization. A $1 gain in a $30 stock is about 3%, but only 0.3% to a $300 stock. A $1 move in any Dow component impacts it the same regardless of the percentage of the move.
The Dow is calculated by ADDING the PRICES of all 30 components and then applying a divisor to the sum. Currently, the divisor is .14748.
For example, if each of the 30 components trade at $100, the sum of the prices will total $3000 (30 X $100). The index is then computed by dividing $3000 by .14748. The resultant calculation produces an index of 20,341.74 (3000/(.14748)).
The method of calculation, while tipping its hat to tradition, is fraught with misleading information. For example, Boeing (BA) is the highest priced Dow component at $312. A 1% gain in BA, or $3.12, lifts the Dow Jones Index by 21.55 ($3.12/(.14784)). A 1% gain in Intel (INTC), on the other hand, is only 45 Cents and adds a modest 3.04 to the Dow Jones Index ((45 Cents)/(.14784)).
Intel has only about 1/8th the impact of Boeing on the Dow Jones Industrial Average. Yet, its market capitalization of $210 Billion EXCEEDS Boeing’s roughly $160 Billion.
Both Intel and Boeing are included in the Standard & Poor’s 500 (SPX). In calculating that index, INTC has MORE impact because it has greater market valuation. In computing the SPX, a 1% move in INTC adds $2.1 Billion ($210 Billion X 1%). By comparison, a 1% move in Boeing will add only $1.6 Billion ($160 Billion X 1%).
The Dow’s “Dive Five”.
The “Dive Five” are somewhat analogous to “The Four Horsemen of the Nasdaq Collapse”. The Horsemen are the dominant 4 technology conglomerates whose market capitalizations each exceeded $800 Billion at one time. Their sheer size dominates movements in the Nasdaq 100 (https://markonomics101.com/2018/08/23/tipping-point-part-2-the-four-horsemen-of-the-Nasdaq-collapse/).
The Four Horsemen are Apple (AAPL $846 Billion), Amazon (AMZN $735 Billion), Google (GOOGL $717 Billion), and Microsoft (MSFT $794 Billion). The Horsemen account for 21.5% of the entire market capitalization of the Nasdaq.
The “Dive Five” of the Dow have disproportionate influence on the index as they tend to be higher priced shares. The Five include Apple (AAPL $172), Boeing (BA $312), Caterpillar Tractor (CAT $122), Goldman Sachs (GS $189), and IBM (IBM $117). This group together accounts for 26% of the Dow Jones Industrials.
AAPL has the rare distinction of being both a Horseman and Dive Fiver. Its chart, included in the slide show below, is completely inconsistent with anything but an almost imminent BEAR.
The “Dive Five” Are Market Leaders
Like the Four Horsemen, the “Dive Five” are all market leaders. It is nearly impossible to imagine a scenario that had Blue Chips like Goldman Sachs, Apple, and Boeing all plummeting during a healthy economy or BULL market.
General Electric, no longer a Dow component, has lost much of its former cache but is highly correlated to economic conditions. With a share price near $7.50, its market capitalization is below $70 Billion. While GE won’t impact any of the major indexes, its fate will be incredibly indicative of the health of both the US and Global Economy (https://markonomics101.com/2018/11/21/stock-markets-bracing-for-recession/).
This is no time to be complacent. Even though “buy the dip” has worked for nearly a decade, the charts point to rough sledding directly ahead. Staying liquid to invest at better levels down the road remains the prudent strategy.
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