Is the Dow Jones Industrial Average (DJIA) really pushing its 2019 year end close during a period of a global coronavirus epidemic? Strangely enough, the answer is dependent on the answer to another question, “what do you mean by the Dow?” That question is particularly germane this year, when the 30 stocks of the Dow have experienced an unusually high turnover of three positions (10%). So the index is not “apples to apples” between even one end and the other of 2020.
The Implications Of Apple's Stock Split For The Dow
The catalyst for the change was that Apple stock was split 4 for 1 after surpassing $500 a share. That, by itself, had implications for the Dow. That's because the index is weighted by the prices of the individual stocks. With its high pre-split price, Apple Inc (NASDAQ:AAPL) formerly had the highest weight of any stock in the index, until its weight was reduced three quarters by the split. (The weights of the other 29 stocks were increased pro rata to make up for the effects of the split.)
In an accompanying move, the Dow's oldest member, Exxon Mobil (XOM), was kicked out, and replaced with Salesforce (CRM), a very different company. Two other changes were closer to "like for like" swaps. With Pfizer (PFE) gone, Amgen (AMGN) is the new pharmaceutical company, and Honeywell (HON) is a stand in for Raytheon (RTX) as a defense contractor. There is a pattern here. Slow-growing blue chips are being replaced by faster-growing, less mature concerns. That tends to boost the value of the Dow beyond what it would have been, had its composition remained constant.
The test of this is that by at least one measure, the Dow is closer to 20,000 than 30,000. And what measure is that? It would be the Dow as of year-end 2010, at current prices, based on the stocks that were in the index on the earlier date, and its closing value of 11,578. That's almost ten years ago, a long enough period of time for a useful trend comparison. Yes the Dow of today is quite different from the index of yesterday.
New Additions To The Dow Stocks
The Dow stocks coming into the current decade (starting January 1, 2011, and ending December 31, 2020) were: AT&T, Alcoa, American Express, Bank of America, Caterpillar, Boeing, Chevron, Cisco Systems, Coca Cola, Disney, Du Pont, ExxonMobil, General Electric, Hewlett Packard, Home Depot, IBM, Intel, JP Morgan Chase, Johnson & Johnson, McDonald's, Merck, Microsoft, Pfizer, Proctor & Gamble, 3M, Travelers, United Technologies, Verizon, and Walmart. Since then, A T& T, Alcoa, Bank of America, Du Pont, General Electric, Hewlett Packard, and Kraft (Heinz) have been dropped from the index (not counting what happened last week). Before the recent changes, Apple, Dow, Goldman Sachs, Nike, Visa, and Walgreens Boots were added.
By using the prices of the stocks of the year-end 2010 Dow instead of the current ones, we came up with a value of 22 687 for the "apples to apples" Dow, as of September 4, 2020. To do this, we had to make some minor adjustments to their closing prices. The value of Kraft (KHC) shares has been adjusted upward by $16.50 to reflect the fact that in the merger with Heinz, Kraft shareholders were given that much cash, in addition to one share of Heinz, to make up the difference in the prices of the two stocks. The value of the UTX shares is not the current Raytheon shares, but that of the old UTX shares that are still "tracked" on the financial markets.
On this basis, the Dow was 24243 at yearend 2019, not 28538. Those numbers would have compared to a 2010 year-end Dow of 11,578. The more than doubling over the previous nine years would still have been impressive, but less so than the 246% gain posted by the reconstructed Dow.
With the year-end 2010 Dow at 22,687 on September 4, 2020, that would be a 9% drop from the end of 2019, not a flirtation with breakeven. In fact, even on its year end 2019 basis, the Dow would be down a similar 9%, if the stocks were equally weighted. In that world, the effect of Apple stock would be 1/30 of the index, instead of nearly one eighth, prior to its split. It was the overweight of Apple (and similarly high priced stocks like Microsoft and United Health) that created the verisimilitude of progress in the Dow. Put another way, while the Dow is flat for the year, a majority of its members are actually down, meaning that the advance of the index has no “breadth.”
A Closer Look
Let's take a look at some individual names. Walgreens has fallen since its addition to the index, but by less than GE, which it replaced. Apple Computer is a much more robust "tech" stock than Hewlett Packard. Goldman Sachs (GS) has a decidedly stronger financial operation than Bank of America (BAC). Nike (NKE) and Visa (V) are much more vigorous consumer goods stocks than AT&T or Kraft (Heinz). United Health is far "healthier" than the decrepit Alcoa. But the choice of Dow over DuPont for the "demerged" chemical weighting was probably a mistake.
The impact of the changes was particularly felt in 2020 during the COVID-19 crisis that is still ongoing. For instance, health care, consumer, and information tech stocks were mostly thriving, while energy, financial, and industrial stocks suffered. So it is possible to create an index that would rise during the pandemic by overweighting stocks in the first three categories, and underweighting concerns in the last three. Which in essence is what happened.
A book title may have said it best: “Lies, Damned Lies, and Statistics." Even though statistics purportedly tell the truth, it is possible to construct lies by mixing and matching them, that is, comparing apples and oranges. The "tinkering" of the Dow, a headline index, is a good example of this. The headline says that things are fine. But the truth is that the strength is isolated, and that the structural underpinnings of the stock market recovery, at least, are pretty weak.
By Tom Au