Know Your Indexes

This week the financial press sqwauked a lot about a possible new stock market all time high. Both Thursday and today were very close to the Dow Jones Industrial Average surpassing its 2000 closing high of 11,722. It fell short by a mere 43 points. But is the Dow Industrial average of just 30 stocks a good measure of the overall stock market? Maybe. Maybe not. By comparison, the S&P 500 Index, covering 500 stocks sits over 200 points below its March, 2000 peak. It must gain another 16% to make it. The methods used to construct these indexes varies, which explains the results. The Dow Jones 30 stocks are price-weighted; the highest priced stocks get more credit in the index. IBM, 3M, Boeing, Atria and Exxon Mobile are the high priced stocks here. The S&P 500 is capitalization weighted, a fancy word for the biggest, most valuable stocks using the price and shares multiplier. Here Exxon Mobile, GE, Citigroup, Bank of America and Microsoft rule the roost. The 5 priciest Dow stocks contribute 26% to that index's rise or fall, while the top 10 S&P 500 stocks influence that index by 21%. I feel that the small number of only 30 stocks in the Dow leads it to misrepresent the overall stock market. As stocks are replaced in these indexes, the Dow stands the most to gain or lose depending on the ensuing performance. What about the NASDAQ index, you may say. It's become popular and is often quoted. It's also capitalization weighted, and is down 44% so far this century. It must more than double from here to reach a new peak.
I'll be launching a new website on my money management services. It should be ready by mid-October or so. Thanks for tuning in.