How IBM and Goldman Sachs Revealed the Dow's Flaws This Morning

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.

On a day when the government avoided what could have been a financial disaster by passing a measure to reopen the government and raise the debt ceiling, you might expect stock markets to soar. But the Dow Jones Industrial Average and other major market benchmarks anticipated the deal with big jumps yesterday, so broader-market measures were largely flat today.

Yet looking only at the Dow Jones Industrials, the average was down almost 90 points as of 10:50 a.m. EDT. The apparent disconnect between a flat broader stock market and a sliding Dow owes mostly to two stocks suffering from poor earnings news: International Business Machines and Goldman Sachs .

Goldman Sachs reported its third-quarter results this morning, and shareholders were disappointed by a 20% drop in the investment bank's revenue during the quarter. Earnings per share actually rose slightly from year-ago levels and beat analyst estimates, but Goldman Sachs said its customers were slow to take action in the choppy market environment. Goldman Sachs had great success with its cost-containment measures, cutting expenses by a full quarter, but even a 10% dividend increase didn't keep the stock from falling 2.6%.

Meanwhile, IBM sank even further, tumbling 5.8% on its own earnings weakness. The tech giant reported that revenue in its hardware segment dropped by 17%, sending overall sales down by 4%. A strong dollar introduced unfavorable currency effects, and International Business Machines managed to post sharp gains in its cloud-based business, along with modest growth in its business analytics segment. But continued sluggishness in IBM's core businesses has led some analysts to worry about the company's future ability to restore overall growth.

Ordinarily, you wouldn't expect two stocks to have such a powerful influence on the Dow. But after the recent changes to the Dow's component stocks, Goldman Sachs and International Business Machines represent two of the three highest-priced stocks in the Dow. That gives them disproportionate weight, as their combined share-price drop of $15 contributed almost 100 points of downward pressure on the Dow -- meaning that the average would be up without their influence.

The conclusion from this is that on days when key Dow components report big news, you can't use the Dow to track the health of the overall market. Stocks are generally doing much better than the Dow would suggest today, showing that the Dow's latest shift hasn't eliminated the potential for misleading results on certain days.

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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 Goldman Sachs. The Motley Fool owns shares of International Business Machines. 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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