The Dow Jones Industrial Average is Useful in a Bad Way

You hear it all the time: The Dow is up slightly in moderate trading. The Dow is steady in light trading. The Dow is down sharply in heavy trading. I could make a bingo card for you, with light, moderate, and heavy trading along one side and up, down and steady along the other. It’s inescapable, tagging the end of news broadcasts on radio and television, and faithfully tracked in the financial sections of news websites.

It is also completely useless as financial information, as broadcast and printed. It is not, however, completely useless.

The Dow Jones Industrial Average was created in 1896 by Charles Dow, founder of Dow Jones & Company and editor of the Wall Street Journal. It was originally a simple average of twelve of the largest industrial companies traded on the New York Stock Exchange. It gave a rough estimate of how the stock market of that time was doing when there were less than 100 listed stocks. Today there are about 2,800 companies listed on the NYSE and 30 stocks in the Dow Jones Average.

Of course, the first problem with the Dow is that it is only 30 stocks out of 2,800, a bit over 1%. Thirty big companies, but an investor could own none of them and dozens of the other 2,770. Aside from massive market wide shocks, a non-Dow portfolio might have no connection with the movement of the Dow.

The second problem is that it is a simple price average. It is calculated by adding up the prices of the 30 stocks and dividing by 30. There is no weighting for the number of shares of stock for individual companies. A smaller company with a high share price moves the Dow more than a larger company with a low share price. Those who practice the dismal science (economics) say that the Dow doesn’t even give an accurate picture of its own stocks.

It’s a number that doesn’t accurately represent the stock market in general, that doesn’t accurately represent any one stock on the market, and doesn’t even accurately represent itself.

I’ll try to be generous and imagine that someone is invested in a Dow Jones index fund, an investment that follows the ups and downs of the Dow. If our putative investor is in for the long term, then day by day, top-of-the-hour updates are useless. If we have a trend focused day trader on our hands, then the hourly updates on the radio and cable news are too intermittent to be useful.

What, then, is its purpose? There are three, two conscious and one that we might call evolved usefulness. The first conscious purpose is to make an effort-free stab at financial reporting. Any news outlet can easily insert a few words about the Dow at the end of a headline roundup and give the impression that some kind of economic news has been delivered. The second conscious purpose is now obsolete. The Dow used to advertise the Dow Jones organization itself, publisher of the Wall Street Journal. To be the keeper of such a supposedly important benchmark lent credibility to the brand. Now the Wall Street Journal is owned by Rupert Murdoch’s News Corp and the Dow has been sold off to the Chicago Mercantile Exchange, or CME.

The third and most important purpose is to make Americans reflexively think that the stock market going up is a good and important thing. This was not a conscious choice by anyone. The Dow just hung on in the public mind after it lost any pragmatic purpose. We can, in part, thank lazy news outlets for that. It is just one part of the mindless cheerleading for the interests of the wealthy. We can also blame the human desire for a simple narrative.

In theory, a stock goes up because the general opinion among traders is that the company underlying the stock is going to be more prosperous in the future than previously estimated. In reality, there are many factors that move stock price, including hype, fear, panic, corruption, emotional contagion, and artifacts of computer trading. Nevertheless, let’s take the long view and focus on value.
There are many ways that a company can be viewed as more valuable. It can bring a new and better product to market. It can be well managed. It can run a successful advertising campaign. Economic and social conditions can randomly favor its business sector. That’s the upside.

On the down side, a company can increase its value in many bad ways. It can have a brutal round of layoffs. It can dodge prosecution for a crime or negotiate a slap-on-the-wrist settlement. It can figure out a loophole in the law that allows it to pollute with impunity. It can get a pliant Congress to give it an unwarranted subsidy or tax break, or a law that favors it at the expense of society in general. It can break a union drive. It can get away with price gouging or deceptive practices. It can abuse and exploit its workers. It can profit from disaster and misery. It can simply plow its profits into buying back its own shares, to the benefit of its top executives and big shareholders. (Note: Share buybacks are not a law of nature. They were illegal before 1982)

An increase in share price is not an unalloyed good for society. This is especially true in that 60% of Americans don’t own any stock.

It is important to those who do own stock, especially those who make the bulk of their income from stock portfolios, that a rising stock market should be seen by the general public as a purely good thing.

My friend Robert Porter has proposed a theory of government in two propositions. The first he takes from Adam Smith; that a government’s primary job is to maintain a system of unequal distribution of wealth. The second is that the equally vital job of government is to maintain the mythology necessary to convince people to accept unequal distribution of wealth. There have been many variations on this mythology through history: divine right of kings, predestination, meritocracy, dictatorship of the proletariat, free markets. The relevance of the Dow is one of these vital myths.

 The air may be poisoned and employees may be living in their cars, but we are supposed to cheer for the Dow. That is the true utility of the endless repetition of the Dow Jones Industrial Average; to distract us from our lived reality and convince us that the true measure of our well-being is the stock value of thirty giant corporations.