Dow(n) Dooby Do, Dow(n) Dow(n)
What are we supposed to do with all the “Dow 15,000” hats now? Keep them handy for another trip on the “Index Round Numbers Express” or just put them up on eBay in the “curios and collectibles” section? ConvergEx's Nick Colas suggests one way to think about the question is to deconstruct the Dow into its 30 components and see which stocks got us to these still-respectable YTD levels in the first place. For example, Colas notes that just seven stocks – MMM, BA, JNJ, AXP, DIS, HD, and HPQ – make up more than half the gains for the Dow in 2013. Most of these names have a distinctly cyclical flavor, of course. And while the Dow has its share of “Defensive” names, it pays to remember that the top 10 companies by weighting take up 54% of the Average. And they need a decent economy to grow earnings...
Via ConvergEx's Nick Colas,
What do the modern Olympic Games, Henry Ford, George Burns and the state of Utah all have in common? The answer is a year: 1896. Yes, 117 years ago Athens held the first modern games, Ford launched his first car, cigar-chomping comedian Burns came into the world, and Utah was accepted into the Union. And while those events might serve to make a century’s worth of events feel close by, also consider that 1896 can feel very far away indeed. A few other notable occurrences from that year:
William Jennings Bryan gave his famous “Cross of Gold” speech, looking to expand the nation’s financial system to accept silver as well as gold to underpin its monetary standard. The age of print-what-you-need monetary policy would have been unimaginable.
New York State passed the Raines Law, which limited alcohol sales on Sunday to hotels. Most workers only had Sundays off – a six-day workweek was the norm – so bars started to offer rooms for rent just to claim the hotel exemption. You can imagine the results… Unintended consequences indeed.
The U.S. Supreme Court ruled that States were allowed to segregate their populations by race under the “Separate but equal” doctrine. The Civil War had only been over for 31 years – the same time span as 1982 to the present day.
Also born in 1896, and with us to this day, is the Dow Jones Industrial Average. The brainchild of publisher Charles Dow, it was a tremendous advance in understanding the general direction of the U.S. stock market. Essentially, Dow took a list of 12 prominent companies’ stock prices, drew a line at the bottom and added. He tracked the result and published it in his stock newsletter, which grew up and became The Wall Street Journal. With one number, Dow could describe the general course of trading over the day in a compact and useful form.
The Dow Average is with us to this day, and largely unchanged from its original form. Yes, there are 30 stocks instead of 12, but there have only been 38 changes to the components in the Average since its formation. It’s technically not an “Index” because of Charles Dow’s method of weighting stocks by price rather than market capitalization. But despite the anachronisms and quirks, it is still the best-known measure of U.S. stock market performance going. Ask most non-professional investors and people outside of Wall Street how the stock market is doing, and chances are good they will use the Dow Jones Industrial Average to answer the question.
That notoriety gives the Dow some power to shift popular perceptions of the state of the U.S. economy, and for that reason alone it is worth studying. Layer on the recent Federal Reserve-induced volatility, and Charles Dow’s late-19th century invention becomes a 21st-century “Transmission mechanism” between Wall Street and Main Street. Simply put, if the Dow swoons further you can bet the proverbial bottom dollar that the average citizen will notice. And worry about their jobs, their house values, and (if they are fortunate enough to have one) their investment portfolios.
In the accompanying table we dissect the individual contributions to the overall gains in the Dow year-to-date for each company in the Average. I am jotting this note in an airport outside Toronto, and my afternoon look at the Dow shows a 2013 gain of some 1,650 points, even with the swoon over the last few days. That’s still a 13% gain, but how did we get here? And what does that tell us about the way forward?
Three points here:
1. Only 7 stocks make up the majority of the Dow’s advance in 2013. They are 3M, Boeing, Johnson & Johnson, Home Depot, American Express, Disney, and Hewlett Packard. Most of these names have middle-of-the-pack weightings (around 3-4%) with the exceptions of 3M and Boeing (5.7% and 5.2%, respectively) and HPQ (only 1.3%).
This math will change slightly for what will no doubt be a tough close today, but by our math these seven stocks have chipped in roughly 900 Dow points in 2013 out of the 1,650 total.
2. As Gilda Radner used to say on Saturday Night Live, “It’s always something”, so I don’t necessarily have a problem with a few names carrying a lot of the Dow’s water in 2013. If it weren’t these, it might be others. The real issue is that as you scan these names you’ll notice that they are, by and large, quite cyclical. This economic exposure might be from individual consumers or large companies, but either way they do require a better macro outlook to generate meaningful earnings leverage.
3. The Dow is as top-heavy a measure of a major equity market as exists anywhere on the planet. More than half the weighting sits at the upper end of the list we’ve appended. The names you need to know are: IBM, Chevron, 3M, Boeing, McDonalds, United Technologies, ExxonMobil, Johnson & Johnson, Caterpillar and Travelers. Yes, if you want to make a bull case for stocks you basically need to tell a good story about some of these names. And it has to make sense with your global outlook, whatever it is.
The long and short of this discussion is as follows:
The Dow Jones Industrial Average is a concentrated and largely cyclical basket of stocks. Most of its stellar performance this year comes from a handful of economically sensitive names.
Its longevity and brand give it inordinate weight in domestic consumer psychology. Even if you don’t have a stock portfolio, you know your job is at risk if the stock market goes down too far or too fast. Or both. Professional investors and avid market watchers have some grasp of the reasons for this week’s volatility. Nobody else will, and they will look at the Dow as proxy for their economic future.
The future performance of the Dow is levered to cyclical names as well, and most are average performers – at best – this year.