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Is the Dow a good market indicator?

Jeremy Hobson Feb 5, 2009

Is the Dow a good market indicator?

Jeremy Hobson Feb 5, 2009


BOB MOON: If you’re here for The Numbers, we’ll get to them in just a bit. But the won’t explain some, shall we say, interesting stock market swings you may have noticed in the past few days.

Lately, we can all count on the Dow Jones Industrial Average for the quick thrill — and not necessarily in a good way. To understand these latest lurches, consider this: The Dow reflects an average stock value of just 30 of the largest U.S. companies. Thirty . . . out of more than 10,000 companies in this country. And it’s “price-weighted,” which means the price of just one of those stocks can have a lopsided effect in determining the average.

So a week like this one raises anew this question: Is the Dow a reliable indicator of what’s happening in the stock market? Here’s Marketplace’s Jeremy Hobson in New York.

JEREMY HOBSON: James Angel is a finance professor who studies the stock market at Georgetown University. He says because of the formula the Dow uses . . .

JAMES ANGEL: Everytime a Dow stock moves by a dollar, the index will move by approximately eight points.

Which means if one of the Dow’s expensive stocks like IBM falls by 20 percent, it will drag the average down by a lot more than the same movement by one of the Dow’s cheap stocks like Bank of America. Hence, the daily volatility of the Dow — and its differences with the broader S&P 500 index.

But, Angel says . . .

ANGEL: As you’ve noticed, these indices tend to go up and down together.

That’s true over the long term. Though any Marketplace listener knows that about once a week, the indexes end up doing different things, and you hear this:

[MUSIC: It Don’t Mean a Thing If It Ain’t Got That Swing.]

No reason to distrust the Dow, says John Prestbo, the executive director of Dow Jones indexes.

JOHN PRESTBO: When you’re looking at just one day at a time, you’re capturing a lot of what the statisticians call noise, which is meaningless movement that has no significance for the longer term.

So what do the pros use? Here’s financial analyst Peter Cohan.

PETER COHAN: I compare my stock picks to the S&P 500 rather than the Dow.

Though he admits the two indexes are not that far off. And he says if you want an index that’ll really tell you what the market’s doing right now . . .

COHAN: It would probably consist of pawn shops, head hunters and bankruptcy and restructuring firms.

In New York, I’m Jeremy Hobson for Marketplace.

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