By Steve Sosnick, Chief Strategist, Interactive Brokers
Some weeks ago, when a 737 crash led to a 10% pre-market decline in Boeing (BA), I offered my opinion that it was time to remove the Dow Jones Industrial Index (INDU) from its prominence in financial journalism.
On April 25, I was recently reminded once again why that index remains an exceedingly poor market gauge.
Consider the case of 3M Co. (MMM). That stock was down about 10% on a rare earnings miss. With a price near $225 per share, the company had roughly twice the influence on Dow as that of $125 Microsoft (MSFT).
Yet again, this exposes the deficiency of relying on price weighting in an influential index. Both companies are behemoths, to be sure, but 3M’s $113 billion market cap is dwarfed by MSFT’s flirtation with $1 trillion!
Quite simply put, there is 9x more money invested in MSFT than 3M. It is silly to arbitrarily give 3M 2x the weight in INDU simply because its price is higher.
Think of the silliness this way: If 3M were to split its shares 2:1, its INDU weight would be cut in half to one approximating MSFT’s.
Nothing meaningful would have happened to MMM’s shareholders, yet that maneuver would have a highly meaningful effect on INDU.
That’s yet another reason why so little money is indexed to INDU compared to the market capital weighted S&P 500 (SPX).
That said, today’s INDU drop does indeed have some useful explanatory value. Remember the 100-plus year purpose of the Dow – to measure the performance of the industrial sector of the US economy.
For better or worse, the sharp decline in 3M has ramifications beyond the company. This is a company that produces a wide range of products, some that are finished goods and others that are used in intermediate stages of production.
While it is imprudent to draw an economy-wide, or even sector-wide, conclusion from one company’s results and guidance, a sharp decline in a company with a broad reach throughout various industries and regions does not bode well for those who are hoping for a solid global recovery.
By the way, an 8% decline in UPS also bodes poorly for global business and the supply chain. Lackluster results from Visa (V) also don’t paint a rosy economic picture.
The flipside of INDU’s underperformance is the outperformance of the NASDAQ 100 index (NDX).
One can complain that NDX is susceptible to the heavy market cap weightings of the leading tech behemoths.
It’s not an argument that will gain much traction in a day when well-received earnings from MSFT and Facebook (FB) are leading that index ½% higher.
All that leads back to the recent middling performance of SPX. By balancing the disparate moves across important sectors of the US economy, it once again provides the clearest picture of the market’s overall health.
This article first appeared on IB Traders’ Insight on April 25
Photo Credit: Richard Walker via Flickr Creative Commons
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