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Marketplace Scratch Pad

Is the Dow irrelevant?

Scott Jagow Mar 10, 2009

Wall Street’s having its best rally of the year today, and reports like this attribute it to Citigroup. The bank claims it was profitable the first two months of the year. Say what?? But Marketplace PM will dissect that assertion. I’m here to question whether Citi is really influencing the markets and whether the Dow has become a joke.

Citigroup’s shares are up 35% as I write this. Wow, sounds huge. That’s 37 cents! Citi’s share price is about $1.40. And because the Dow is price-weighted, Citi’s gain for the index could be wiped out if let’s say, IBM, drops 37 cents. IBM is $85 a share, the highest price on the board. To IBM, 37 cents is a fraction of a fraction.

The Bloomberg story says:

“Stocks around the world staged the biggest rally of the year after Citigroup Inc. said it was having its best quarter since 2007, spurring speculation the worst of the banking crisis is over.”

A. I believe I’ve heard that before. B. This rally probably has very little to do with Citigroup.

FIrst of all, there’s plenty of skepticism about Citi’s position. But let’s talk about short selling. As Ben Halliburton of Tradition Capital Management explains in this article, the gain in financial stocks can be attributed to “short covering.” There’s been a lot of short selling lately because stocks keep going down, and that’s what short sellers live on. But when stocks go higher, short sellers have to buy, buy, buy and cover their positions. It’s very likely what’s happening today.

There’s also word that the SEC might bring back the uptick rule. The uptick rule is supposed to prevent short sellers from doing what they’ve been doing – exacerbating the market’s downturn. In a case of fantastically bad timing, the SEC eliminated the rule in July, 2007. Maybe it wasn’t a big deal when the market was going up, up, up, but it’s a big deal now. What’s the SEC waiting for? The Dow to hit 5,000?

Oh yes, about the Dow. Why is Citigroup still on it? Usually, the Dow clears off dollar stocks. Based on what I’ve read, Citigroup and GM, maybe others, could be replaced with the likes of Google, Cisco or Visa.

I know everyone loves the Dow for its simplicity. 30 stocks. Well-known companies. But does it really reflect anything other than a very rough sketch of the stock market? In the article I just cited, Paul Nolte, director of investments at Hinsdale Associates, asks:

“Does it represent the largest and best companies in the U.S.? If so, I think you can probably argue that a third of the companies should probably go. But if you want to say they represent various industries and replicate what is going on in the U.S. economy — it’s doing that under current conditions.”

Maybe. But Motley Fool recently argued the Dow not only needs to clean house, but to update its model:

“The index, quite frankly, is a joke. It’s not just that the DJIA is limited to just 30, mostly crusty, stocks. The biggest flaw in the iconic gauge is that it is a price-weighted average… It can get with the times and adopt a value-weighted metric.”

Even if the Dow doesn’t reflect anything, stocks are up elsewhere today too — 5-6% gains for the NASDAQ and the S and P 500. I guess we’ll finally get to play the “We’re in the Money” music tonight on Marketplace.

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