Morning Dow Report: Has the Dow Become Irrelevant?

Morning Dow Report: Has the Dow Become Irrelevant?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The Dow Jones Industrials gave investors another conundrum to deal with today, as earnings-related moves caused the average to diverge once again from the direction of the broader market. Even as the S&P 500 and Nasdaq stayed close to breakeven in early trading, the Dow was down 65 points as of 11 a.m. EST. If that disparity persists, it would mark the third straight day that the Dow and S&P moved in opposite directions. That's making many investors ask a simple question: is the Dow still relevant as a stock market benchmark?

The problem that the Dow faces is that by encompassing only 30 stocks, even a single company-specific news item can move the entire average. Earnings season is a fertile time for such moves, and this morning we're seeing IBM have a huge impact on the Dow, with its nearly $6 per share drop equating to between 35 and 40 points of downward pressure on the average. Recently, this phenomenon has worked in both directions. Last Friday, the Dow rose even as the broader market sank, as positive earnings from member company American Express led to greater enthusiasm about the credit card industry.

Moreover, recent Dow moves have only increased the likelihood of market-moving news from a single stock. Again using Friday as an example, the Dow's gains came much less from AmEx itself and much more from Visa , which gained more than $10 per share on hopes that the Federal Reserve would assert itself in looking for a higher cap on card swipe fees. Visa now has the strongest influence on the Dow, with a 9% weighting. The addition of Goldman Sachs has also made the Dow much more top-heavy, and with Goldman vulnerable to changing conditions in the financial industry that often result from broader economic moves, investors can expect to see greater volatility in Goldman shares than in a typical blue-chip stock, as its beta of 1.84 attests.

Yet fundamental growth in many Dow companies and a lack of stock splits have also contributed. Boeing has a 5.5% weighting in the Dow because of its massive stock-price gains, following on the heels of huge increases in aircraft demand over the past year. Yet because it and other strong-performing companies have chosen not to implement share splits, there are now seven Dow stocks trading at $100 or more, and the top nine Dow components have more than half of the overall influence on the average as a whole.

The lesson that investors need to learn from this is that the Dow no longer reflects the overall daily movements of the broader stock market. Especially at times when individual companies are reporting news, you have to look beyond the blue-chip index to get a true reading on the health of stocks generally.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends American Express, Goldman Sachs, and Visa. The Motley Fool owns shares of International Business Machines and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published