The Devil In The Details Of The Dow
It looks like the Dow Jones Industrial Average will be the first major U.S. equity benchmark to breach new highs, so ConvergEx's Nick Colas breaks down this closely watched measure of domestic stock prices noting that the Dow is a quirky “Index” – price weighted (not market capitalization), compact (30 names) and fundamentally global (lots of brand-name multinationals). Change just one name in the index, and the outcomes vary considerably. If Google had been added at the end of last year, we’d be at 14,330 – well over the old high of 14,165. But if the Dow committee had added Apple instead, the index would have closed at 13,475 yesterday, up less than 3% on the year. And if Netflix had been the lucky company added for 2013, well… We’d be saying hello to Dow 15,000, and then some. As for the “Real” Dow, it remains cheap on forward multiples as long as the Street’s estimates are solid.
ConvergEx's Nick Colas: Mama, Take this Badge off of Me,
“If it bleeds, it leads” is a well-used aphorism in newsrooms around the world. Actually, if you want to get old-school, it should be “Ledes.” That quirk of the fourth estate comes from a desire to differentiate “Lead” – the metal used to hold strips of news type on a printing press - with the “Lead” paragraph of a story. Either way, the top of an article, the first story on the evening news, the beginning of a radio news program, has to get the attention of the reader-listener-viewer. That means the sensational and scary have a better chance of getting press than the uplifting and mundane.
There’s one exception to the “Bleeding lede” rule, at least when it comes to financial reporting: the “Record high” close for a closely watched index. And since there is no better known measure of U.S. stocks than the Dow Jones Industrial Average, the fact that we’re “Knocking on Heaven’s Door” at +14,000 means we should spare a moment and consider what a new record means to capital markets and investors. A few points to kick things off:
- The all-time record close for the Dow was 14,164.53 on October 9th, 2007. Things didn’t go so well after that, of course. The Dow subsequently bottomed at 6,547 exactly 15 months later.
- The famous Dow 10,000, immortalized on hats that still clutter trading desks around the Street, had its debut on March 29th, 1999. The last time we were in that neighborhood was June 2010.
- Going into ancient history – something the Dow, started in 1896 can do better than the much younger S&P 500 – the first time the Dow crossed 100 was January 12, 1906. It took until November 1972 to hit 1,000 and November 1995 to hit 5,000.
- We need 111 points, or 0.8%, to hit a new high based on today’s close. The S&P 500’s closing high of 1565.15 is 50 points away, or 3.3%. The tech bubble of the NASDAQ back in 2000 puts that index at a distant third – the record is +5,000 and yesterday’s close was 3,160.
To understand how this year’s rally has gotten us so close to a record close, it pays to dissect the Dow into its 30 component companies and look at how much each company’s performance has contributed to the gains. We’ve done that in the attached table, and here is a summary of what we found:
- The ten most heavily weighted names in the index – IBM, CVX, MMM, MCD, CAT, UTX, XOM, TRV, BA and PG – are responsible for 543 points (or 57%) of the total 950 point advance for 2013. This is large part due to the price-weighted nature of the Dow. Bigger stock price equals bigger weighting. Market caps, unlike in the S&P 500 or NASDAQ indices, mean nothing in the Dow.
- The top contributor is IBM, up 4.8% on the year and adding 70 Dow points. Yes, that is an underperformance to the Dow’s 7.3% advance in 2013, but because IBM is 11% of the index, it is still the most important plus factor for the Average.
- Only 3 Dow stock are down on the year: Alcoa (-1.8%), Bank of America (-3.3%) and UnitedHealth (-1.5%). Their drag on the Dow: a total of 9.4 points.
- If you are wondering if the Dow is out of runway once it crosses into new high territory, consider the valuations of those Top 10 most heavily weighted names. We’ve included that data in the accompanying table as well. Based on analysts’ earnings expectations for 2013, these stocks trade for 13.3x earnings and 12.4x next year’s numbers. You always have to take these estimates with a large grain of salt, to be sure… But 12-13x forward numbers is no one’s idea of an “Expensive” market.
Since the Dow Jones Industrials are a pretty rarified club – just 30 household names – there is a cottage industry which operates a lottery about what names might be added to this best-known measure of the U.S. stock market. It’s not that there is a ton of money benchmarked to the Dow – the S&P 500 and various Russell indices have a strong hold on that business. But there is an indisputable cache to the Dow, if only due to the 30-name limit.
What if Google or Apple or Netflix had been added at the end of last year? Household names all, to be sure. We ran that math for these names and a few others (some rough math included in several attached tables) and here’s what we found:
- Apple. The boys and girls from Cupertino have hit a rough patch, with the stock down 17.1% year to date. Since AAPL has a large stock price – over twice that of IBM – this performance would have hit the Dow quite badly: about 435 points as we figure it. This would have put the Average at a close of around 13,475 yesterday, rather than the actual 14,054.
- Google. I am absolutely not going to order those freaky glasses, but GOOG itself has done well in 2013, up 13.3%. That’s good for 800 Dow points (big stock price like AAPL, but moving in the right direction) and a new record closing high yesterday of 14,330.
- Netflix. The best performing stock in the S&P 500 year to date, and a price that would make it the 2nd most influential stock in the Dow, right behind IBM. NFLX has been a double year to date, which would have been around 1,200 Dow points. And a closing high yesterday of 15,275.
- LinkedIn, Time Warner, and Salesforce.com: LNKD in the Dow from January 1 would have put the Dow on track to close around 14,533 yesterday. TWC hasn’t had as good a year, so the Dow would be just below 14,000. And CRM – almost no difference to the end of February close.
The point here is that the notion of a “New High” for the Dow is a little arbitrary, by virtue of the price weighting function and stock selection process. No, I don’t think Apple or Google would make it into the Dow – the price weighting would essential relabel the Average as “Apple/Google and 29 other companies.” But LinkedIn – and scores of other companies – could have easily lifted the Dow to a new high. Would the Dow committee every chose such a newbie to include? Hard to tell.
Ultimately, “You dance with who you brung,” and the Dow seems to be our date to the “New High” prom. That the oldest measure of US stock market performance is the first to accomplish this feat perhaps surprising, to be sure.
But it is still nice to see it in the lead.
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