Distortion In The Dow Jones Index

The Big Picture shares an article from James Bianco entitled “The Dow is Distorted” which addresses some recent anomalies in the components in the Dow Jones Index.

Specifically, Bianco argues that the Dow Jones is violating its own ‘unwritten rules’ that any stock that trades less than $10 per share will be excluded from the Dow Index, and at the time of his writing, three stocks traded less than $10:

Citigroup (C): $3.33
General Motors (GM):  $3.38
Bank of America (BAC):  $6.00
Alcoa (AA):  $8.35

These were the stocks and their closing prices as of Monday, January 26, 2009.

Furthermore, Bianco explains how the Dow - as a price-weighted index - changes value.  A $1.00 change in a component’s stock translates to an 8 point move in the Dow Jones Index (7.96 to be exact).   Thus, it wouldn’t matter much if any of these four stocks “went to zero” tomorrow, as it would only create a slight discomfort to the Dow Index.

However, as a price weighted index, stocks whose values are greater can contribute more to the movement of the Dow Jones, such as any of the higher-priced stocks such as IBM (IBM), Exxon-Mobil (XOM), or Chevron (CVX).

Read the article for additional information and ideas.

Despite the fact that the Dow Jones Index is comprised of only 30 stocks, it roughly matches the movements of the S&P 500 Index more than not.  It may be easier to follow (track) the movements of 30 key stocks, but the S&P 500 is expected to be a better barometer of “the market,” particularly as the Dow Jones remains ‘distorted’ by the fall-out of the credit crisis.

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