The Dow is Dead, Long Live the . . . ?

Monday, August 31st, 2009

Rolf Benders has a interesting article today in the German business newspaper Handelsblatt (“Wall Street’s old rules”) that points out something important which nonetheless few of us (including certainly myself) have realized: this “Great Recession” that kicked off in 2007 has wreaked pure havoc on the Dow Jones Industrial Average.

That is of course the mostly widely-watched stock exchange index, which additionally serves as the basis of numerous index funds as well as derivatives traded on the Chicago exchanges. But lately, as Benders points out, it has been all messed up. Those that determine the make-up of the elite 30 companies that make up the Dow don’t like to change that very often; there have been only 27 changes since 1976, and no changes made at all in the periods Nov. 1999 – Apr. 2004 and Nov. 2005 – Feb. 2008. But such stability also can be bad: it’s only recently that GM, AIG, and Citigroup were removed from the Index, i.e. long after it was clear in all three cases that catastrophic misfortune (to give a charitable interpretation) together with substantial government intervention were making any objective valuation of their outstanding stock’s value impossible. GM had been part of the Dow since 1923; now the only company left of the original 12 (from the beginning in 1896) is General Electric, which itself is not doing so well these days either. (The three kicked-out were replaced by Kraft Foods, Cisco, and Travellers Corp.)

The Index is too volatile; it’s not volatile enough; but forget all that, boiled down to its essence Benders’ complaint against the Dow is simply that it is composed according to the decisions of the editor-in-chief of the Wall Street Journal. Here he has his own agenda, which is precisely to talk down the Dow and so talk up the DAX (or Deutscher Aktien IndeX, essentially the “Dow” or blue-chip index for the Frankfurt Stock Exchange). It’s true that the latter has had its composition changed 29 times already since it was created in 1988, so Benders is willing to call it “shameless” (schnöde) – but it’s at least also put together in a transparent way,* unlike the Dow which remains subject to the opaque and arbitrary whims of one particular editor.

Anyone in the know about the American securities markets has long known anyway that the Dow Jones Industrial Average inevitably gives a distorted picture of the state of the securities markets there. But Benders is living in his own fantasy-land – the one clearly marked “Off limits!” for serious business reporters of all stripes, German or otherwise – if he really believes that the DAX will take over the Dow’s place anytime soon as a closely-watched indicator. This issue transcends mere questions of the validity of one index’s composition versus another’s, in favor of larger issues like the world-wide impact of one country’s securities markets versus another’s. Ground-shifting changes along those lines in the future can certainly not be ruled out – no more than anyone should bet that the US dollar will remain the world’s reserve currency forever – but minor objections over one index’s “transparentness” versus that of some other index will hardly be the way that we all get there.

* Benders doesn’t specify in his article how the DAX is “more transparent,” but the claim is probably valid since it is automatically calculated from the current share-prices of whichever happen to be the 30 largest German companies in terms of order book volume and market capitalization.

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