Last month, while I was in the lobby chatting with a novice investor, an interesting question arose. With hesitation in her voice, the investor looked at me and said, "Genevieve, I have a stupid question to ask you. What does ‘Dow Jones'mean? I have attended dozens of review meetings, but always partway through I get lost in the mumble and jumble. Can you explain to me the basics, so I am not entirely lost?'"
Birth of the Dow
The Dow Jones Industrial Average is the most historical market index. In fact, it was the first US index. In 1882, three young reporters, Charles Dow, Edward Jones, and Charles Bergstresser, founded Dow Jones & Co in a basement office near the New York Stock Exchange. Dow Jones launched its first stock indicator in 1884 with an index largely composed of railroad stocks. On May 26, 1896, the company launched what is now known as the Dow Jones Industrial Average, or the Dow.
With an opening value of 40.94, the Dow became the world's most extensively followed stock market indicator, tracking the world's largest stock market. According to the Dow's Web site (www.averages. dowjones.com), the "average is computed in realtime continuously throughout the trading day and is maintained and updated by the editors of the . When the Dow was established in 1896, it consisted of 12 stocks. The average was increased to 20 in 1916, and then to the current 30 stocks in 1928."Throughout the years, the prestige of the Dow has fallen behind the Nasdaq and the S&P 500. The United States has become a robust service industry, and the "industrial"nature and stock size of the Dow has played a large role in the regression of its dominance.
In 1928, the first 30 stocks were added to the index. The Roaring '20s sparked a market rally, but unfortunately the 1929 crash halted the index's growth. The decade closed at 248.48. In the 1930s, stocks continued to do miserably. In July 1932, the average hit a low of 41.22. By the close of the decade, the index was at 150.24. This was a 98.24-point drop from the previous decade.
The 1950s was the best decade for the Dow until the 1990s. The end of the Korean War sent the Dow upward. At the end of the decade, the Dow closed at 679.36, which was a 269.46% increase from the previous decade. In the 1970s, the Dow hit the remarkable 1000 mark. However, the Dow closed the decade only 4% higher than the preceding decade, as bearish market tendencies moved to the forefront.
The 1980s was full of panic and glory. Black money and the silver market crisis sent investors into a tizzy. But at the end of the tailspin, the greatest bull market run began. Wall Street saw real fireworks in 1987. According to the Dow's Web site, "The industrial average started the year at 1895.95, then staged one of the most impressive advances in history, surging nearly 44% and peaking at 2722.42 on Aug. 25. In the fall, it turned around and suffered one of the biggest declines on record, dropping nearly 1000 points in 2 months. The selling crescendo peaked on Oct. 19, with a 508- point crash, the worst 1-day drop ever (nearly 23%)." At the end of the decade, the Dow closed at 2753.20.
The 1990s held the greatest ever bull market run. The first 10,000-mark close was on Mar. 29, 1999. Throughout the 1990s, the Dow jumped 8743.95 points, which was a 317.59% increase from the decade before. The Dow closed the decade at 11,497.12.
From the close on Dec. 31, 1999, to the close on June 31, 2004, the Dow has been down. According to John Valentine, principal investment advisor at Valentine Capital Retirement Planning Group, "The Dow in the 2000s should mimic the nature of the 1970s. We saw the Dow hit record highs, but it also trailed the average growth from the prior decade."Economists and advisors alike say the decade shows promise.
Dow averages are uniquely different from other index averages. The Dow is price-weighted rather than capitalization-weighted. In contrast to other indexes (eg, the S&P 500), which are affected by price changes and changes in the number of shares outstanding, the Dow is affected only by price changes. To calculate the Dow average, add up the current prices of the 30 stocks contained within the index and then divide that number by the Dow Divisor, which is frequently modified. The Dow Divisor is a number that takes stock splits and other market changes into account.
The differences between a price-weighted and a capitalization-weighted index are significant. The S&P 500 consists of many mega-capitalization stocks. The largest of them (eg, Microsoft, General Electric, Intel, Wal-Mart, Merck, Citigroup, Exxon, and IBM) represent a considerable fraction of the general index score. This means that the S&P 500 price is far more vulnerable to the swings of the underlying stock performances of these specific companies than the Dow, which, unlike the S&P 500, maintains a price-weighted philosophy.
has a strong background in ethical research
and the investment industry. She works full-time for the Valentine
Capital Asset Management of San Ramon, Calif, and is the
chief editor of their "High Net-Worth Newsletter,"published
monthly. She is currently working on her master's degree in ethics.
She welcomes questions or comments at 925-275-0200 or visit
www.vcrpg.com. This article was produced with contributions by
Valentine Capital Asset Management's John Valentine, Mike
Rowland, and Greg Costa, and by John Gardner, president of Equity
Research & Portfolio Evaluation, Inc.