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There’s a big problem with the Dow

There’s a big problem with the Dow

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There’s a big problem with the Dow

There’s a big problem with the Dow
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If you follow the Dow Jones industrial average, you may be wasting your time. And if you invested in the Dow instead of the S&P 500 this year, you’ve actually missed out on a lot of gains.

Despite a 1 percent rally on Monday, the Dow is up just 1.6 percent since the start of 2014. Meanwhile, the S&P 500 has gained 6.7 percent.

So what explains the discrepancy?

“For at least the past decade, if not longer, [the Dow] really is too concentrated, too focused on large caps,” said Erin Gibbs, equity chief investment officer at S&P Capital IQ. “Inherently, [it] has some problems with it being representative of the overall market.”

While the Dow is composed of just 30 stocks, the S&P 500 index is a market capitalization-weighted index of 500 companies. The funny thing is that both are among the 830,000 indexes administered by S&P Dow Jones Indices.

“The S&P 500 really just has a much more diverse and broad array of industries and sectors you can have exposure to,” said Gibbs. “So our preference is heavily the S&P 500, but mainly because of the valuations and the growth when you look at the two indexes.”

According to Gibbs , the outperformance may continue. The S&P 500 is valued at roughly 15.6 times the next 12 months’ earnings, while the Dow is at 16.2 times its forward earnings.

Ari Wald, head of technical analysis at Oppenheimer, agrees with Gibbs.

“I don’t think the Dow is a great reflection of the market anymore,” Wald said. “It only covers 30 stocks. It also puts too much emphasis on the price rather than a market’s capitalization.”

When comparing the top-weighted stocks in the Dow versus the S&P 500, one can see just why the latter has done much better, said Wald.

Dow top-weighted stocks

Year-to-date change

 

S&P 500 top-weighted stocks

Year-to-date change

Visa

-3.7%

 

Apple

+23.7%

IBM

-1.0%

 

Exxon Mobil

-1.7%

Goldman Sachs

-1.5%

 

Google

+5.7%

3M

+2.8%

 

Microsoft

+20.5%

Chevron

+1.1%

 

Berkshire Hathaway

+13.9%

Boeing

-8.4%

 

Johnson & Johnson

+12.1%

View photo

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Wald also furnishes a chart of the price of the Dow divided by the price of the S&P 500, which shows more relative weakness ahead for the Dow.

“If you look at the relative relationship between the two, that falling line shows that the Dow Jones industrial average has been underperforming since 2012,” Wald said. “There is catch-up potential here but we think the Dow needs to perform in-line with the S&P 500 before it can be outperforming the S&P 500. In other words, that line needs to base. Until then, the trend favors the S&P 500 and we do, too.”

To see the discussion on the Dow versus the S&P 500, with Gibbs on the fundamentals and Wald on the technicals, watch the above video from CNBC’s “Street Signs.”

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