A Reason to Fret About the Dow ETF

ETF Trends

In what has been a mostly banner year for U.S. stocks, the SPDR Dow Jones Industrial Average ETF (DIA) , the tracking ETF for the venerable blue-chip index, has gained 17.7%.

That move is made all the impressive when realizing that four of the top-10 holdings in the price-weighted index have been disappointments this year. International Business Machines (IBM), DIA’s second-largest holding, is down almost 7%. Chevron (CVX), McDonald’s (MCD) and Exxon Mobil (XOM) have all produced returns that cannot even come close to DIA. [Dow ETF Sees Earnings Deluge]

Yet those are not the real causes for concern with DIA and the Dow. A possible repeat of market history is. U.S. stocks are not cheap, but there have been previous periods of market ebullience when U.S. equities have been pricier than they are today. Think 1987, 2000 and 2007. DIA has a P/E ratio of almost 15 and a price to book ratio of nearly three, according to State Street data.

The problem could be one of too far too fast.

“While valuations are not at extremes, stocks rarely record the types of gains witnessed since the 2009 lows. Over the past 40 years, there have only been two other instances in which stocks have rallied this far this fast: the run-up to the 1987 crash and the late 1990,” said BlackRock Chief Investment Strategist Russ Koesterich in a recent note.

Using the Dow’s run-up in the mid to late 1990s as an example, the blue chip index surged from its post-early 1990s recession lows, but all of those gains and then some were given back when the tech bubble burst the economy soured earlier this century.

An extended view of Dow history paints an even more concerning picture. There were two periods in which the Dow more than tripled in five years:  During the Roaring 1920s and in the days leading up to the Great Depression.

DIA is still a long way from tripling off its post-crisis lows and that may not be a bad thing. The potential for further gains exists given the increasing weight to cyclical, higher-beta fare within the Dow. That is if the U.S. economy cooperates. [Changes Coming for Dow ETF]

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Chart courtesy: BlackRock. Click to enlarge.

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