Stocks Updates
“A rising tide lifts all boats, but every year some vessels in the stock market spring a leak. Broad diversification ensures they won’t sink the whole portfolio.”
- Weston Wellington, Vice President, Dimensional Fund Advisors
By Selwyn Gerber:
In polite conversation, appropriate people know to avoid conversations about religion and politics. That leaves many with only a few topics of discussion, such as sports or the arts. The one topic bandied about most, however, might very well be the stock market. The Dow was up 100 points, NASDAQ was down 20 points, etc. To the uninitiated it is not clear at all what these oblique monikers are referring to. Generally, when people talk about the “market” behaving in a certain way, they are talking about an index.
A stock market index is a basket of stocks whose price reflects the composite value of its components. The stocks that make up an index share some common feature such as the fact that they all trade on the same stock market exchange, they all belong to the same industry, or they all have similar market capitalizations. Many indexes are maintained by news organizations, such as the Dow Jones Averages, or financial services firms, like the S&P 500. Indexes are commonly used to compare the performance of portfolios such as mutual funds.
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Stock market indexes may be classified in many ways. Broad-base indexes represent the performance of the entire stock market. The most common market indexes are broad-base indexes comprised of the stocks of large companies listed on a nation’s largest stock exchanges, such as the American Dow Jones Industrial Average and S&P 500 Index. Similar indexes provide measures of market activity in other countries. Examples include the British FTSE 100, the French CAC 40, the German DAX, the Japanese Nikkei 225, the Indian Sensex or the Hong Kong Hang Seng Index.
Specialized indexes were created to track the performance of specific sectors of the market. The Dow Jones Transportation Average, for example, consists of 20 companies in the transportation industry, including railroads and trucking companies. Other indexes may track companies with even more specialized criteria. The American Stock Exchange Interactive Week Internet Index tracks stocks of 42 companies that sell products and services related to the internet.
The Dow Jones Industrial Average (also called the DJIA, Dow 30, or informally the Dow Jones or the Dow) is one of several stock market indexes created in the late 1800s by Wall Street Journal editor and Dow Jones & Company co-founder Charles Dow. Dow compiled the index as a way to gauge the industrial performance of the US economy. It is the oldest continuous U.S. market index, along with the Dow Jones Transportation Average, which Dow also created.
Today, the Dow average consists of 30 of the largest and most widely held public companies in the United States. The “industrial” portion of the name is for the most part historical. Most of the 30 modern components have nothing to do with heavy industry. The average is price-weighted, meaning we should be able to add up the prices of the 30 stocks, divide by 30 and obtain the average. Over the years, there have been a large number of stock splits and other adjustments to the average, which required changes to the way the average is calculated. Whenever one of the component stocks has a stock split or stock dividend, the number that the sum of all prices is divided by to generate the value of the index, the “divisor,” will change in order to reflect the change in outstanding shares. In early 2008, the value of the DJIA divisor was 0.123017848. Since the divisor is less than one, the value of the index is higher than the sum of the component prices.
The DJIA was first published on May 26, 1896, and represented the average of twelve stocks from important American industries. Of those original twelve, only General Electric is currently part of the average. The other eleven were:
• American Cotton Oil Company, distant ancestor of Bestfoods, now part of Unilever
• American Sugar Company, now Amstar Holdings
• American Tobacco Company, broken up in 1911 antitrust action
• Chicago Gas Company, bought by Peoples Gas Light in 1897 (now an operating subsidiary of Integrys Energy Group, Inc.)
• Distilling & Cattle Feeding Company, now Millennium Chemicals, a division of Lyondell Chemical Company
• Laclede Gas Light Company, still in operation as The Laclede Group, removed from the Dow Jones Industrial Average in 1899
• National Lead Company, now NL Industries, removed from the Dow Jones Industrial Average in 1916
• North American Company, (Edison) electric company broken up in the 1940s
• Tennessee Coal, Iron and Railroad Company in Birmingham, Alabama, bought by U.S. Steel in 1907
• U.S. Leather Company, dissolved 1952
• United States Rubber Company, changed its name to Uniroyal in 1961, merged private with B.F. Goodrich in 1986, bought by Michelin in 1990
In a vibrant and dynamic economy, there are clearly no longer “evergreen” companies, Indexing allows an investor to be sure he is participating in the ongoing evolution of the economy and as new companies come into being the portfolio will automatically include those while dropping enterprises that no longer belong in the index. So while holding an index is passive from the standpoint of the investor, the portfolio itself is internally dynamic and changing in response to the changes in the economy.
“The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers, goods, the new methods of production …that incessantly revolutionizes the economic structure from within …destroying the old one…creating a new one. This process of Creative Destruction is the essential fact about capitalism”
- Joseph Schumpeter, Economist Capitalism, Socialism and Democracy 1942.
When it was first published, the index stood at 40.94. It was computed as a direct average, by simply adding up stock prices of its components and dividing by 12, the number of stocks in the index.
In 1916, the number of stocks in the index was increased to twenty. It was increased to thirty stocks in 1928, near the height of the “roaring 1920s” bull market. Components change regularly, at the discretion of the Dow Jones company.
Movement in the Dow has been steadily upward, mirroring the strong growth of the U.S. economy. Major milestones are highlighted in Table 6-1.
History of the Dow Jones Industrial Average
100 January 12, 1906
Milestone First Recorded Days to Reach
1,000 Nov. 14, 1972 21,651
2,000 Jan. 8, 1987 3,572
3,000 April 17, 1991 1,079
4,000 Feb. 23, 1995 974
5,000 Nov. 21, 1995 188
6,000 Oct. 14, 1996 225
7,000 Feb. 13, 1997 84
8,000 Jul. 16, 1997 104
9,000 Apr. 6, 1998 181
10,000 Mar. 29, 1999 245
11,000 May. 3, 1999 23
12,000 October 19, 2006 1,878
13,000 April 25, 2007 126
14,000 July 19, 2007 85
Source: Dow Jones & Company & RVW Research
Table 6-1: The time between major milestones in the Dow varies a great deal, highlighting the risk of being out of the market and missing a significant gain.
The S&P 500 is an index containing the stocks of 500 large cap companies, most of which are American. The index is the most widely known of the many indexes owned and maintained by Standard & Poor’s, a division of McGraw-Hill. The S&P 500 index forms part of the broader S&P 1500, measuring the performance of the U.S. stock market, and the S&P Global 1200 stock market index which is designed to reflect worldwide trading activity.
All of the stocks in the S&P 500 are large publicly held companies and trade on the two largest US stock markets, the New York Stock Exchange and Nasdaq. After the Dow Jones Industrial Average, the S&P 500 is the most widely watched index of U.S. stocks. It is considered to be a leading indicator of U.S. economic activity and is a component of the Index of Leading Indicators maintained by the government.
Many index funds and exchange-traded funds track the performance of the S&P 500 by holding the same stocks as the index, in the same proportions, thereby attempting to match its performance, before fees and expenses. Partly because of this, a company which has its stock added to the index may see a quick jump in its stock price as the managers of the mutual funds must purchase that company’s stock in order to match the funds’ composition to that of the S&P 500 index. Likewise a company being deleted from the index may experience a sudden decline in its stock price.
