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Independent financial advisers founded in 1975
Over £1.4 billion client funds under management
17 industry awards for advice since 1989

By Alan Steel, Chairman

Alan Steel is chairman of Alan Steel Asset Management

Alan Steel Asset Management is regulated by the Financial Conduct Authority. This article contains the personal views of Alan Steel and should not be construed as advice. Do check your individual circumstances with your advisers.

Getting the measure of a market index

On the money: Stop worrying about the rise and fall of a table of shares, says Alan Steel
By Alan Steel | Friday, 25 June, 2021

“There are two kinds of worries- those you can do something about and those you can’t. Don’t spend any time on the latter” Duke Ellington

“Since 1916 the Dow Jones Index has made new all-time highs less than 5% of all days, but it’s up 25,568% over that time. The less you look the better off you’ll be” Michael Batnick,  March 2021

Every week I phone my old auntie Irene in Canada. It used to be every Thursday night (she’s 8 hours behind us in British Columbia) but when I found out that she never sees anybody on Saturdays I switched the day so that she had something to look forward to at the weekend. She’s been in Canada since she emigrated 63 years ago but she’s never lost her Scottish accent or forgotten her roots. So she still makes Scotch Broth and mince and tatties on special occasions for her extended family which bemuses those who have never set foot in Scotland. Her Caledonian diet must have been a success though, given that she celebrated her 90th birthday last week.  

Thanks to lockdown she’s been isolated from friends and family for the best part of 15 months and thus, despite her fast failing eyesight, spends most of every day glued to American and Canadian TV News. And sadly for her, she believes every word she hears. So most of the last four years she would tell me how awful Trump was, how Brexit was tearing Europe apart, how rising tides were going to submerge Manhattan , and that investing in ‘the stock market’ was a mug’s game.

All week she saves up complicated questions for me. When I last phoned, her first question was “How are you coping with the awful falls last week in the Dow?” “What falls?” I asked. “The ones in the Dow Jones” she replied, “It is the same thing, the Dow is the Dow Jones, isn’t it?” “Yes” I said, “But I don’t know what you’re talking about. There’s been nothing that’s happened out of the ordinary that I’ve noticed, to be honest.”

“You are kiddin’“, she replied “It’s been on the news for the last couple of days that the Dow is crashing and an expert said it’s the worst falls in ten years. Now to be honest I don’t know what the Dow is, but  experts are saying this is terrible news for investors and it’s probably too late to sell your shares.”

So I tried yet again to remind her that her TV news broadcasts were just like ours in that their objective is to find bad news from all over the world, then pick the worst to make sure you keep watching, (so they can sell more advertising) because they’ve discovered that bad news fascinates and attracts more viewers, whereas good news is boring and doesn’t make them any money.

But then she asked “Surely when experts are saying it’s bad, it must be bad, because they’re experts after all?” And my response to that question is based on a quote from legendary economic straight-talker J K Galbraith, economic adviser to President Kennedy, who said “Never forget that experts you hear on TV or radio are the experts that have been chosen to be interviewed.”  

I’ve found that to be spot-on over the years. I recall BBC News asking if I’d be interviewed about pension issues that were supposed to be worrying would-be pensioners big-time. I said I’d be happy to take part, but when they established that my views didn’t agree with the line they wanted to take, they said “thanks, but no thanks” and went off to find an advisor prepared to go along with their gloomy version.  

Concerned that I may have somehow missed a market collapse, on Monday I checked Dow Jones performance statistics from the week before. On Thursday 17th the Index stood at 34,014. By Monday afternoon it was down on Thursday’s high by less than 0.4%. Putting that into perspective the Index is up over the last year by 19%, and since the market bottom in March 2020 when Covid pandemic fears were at their most extreme, the Dow is up over 54%. I don’t remember seeing that being mentioned anywhere recently, do you?

Going back to November 2016 when Donald Trump’s shock victory in the US Presidential Election brought out arch-pessimists in droves, when Nobel Prize winning economist Paul Krugman, was asked for his predictions, he wrote: “If the question is when markets will recover, a first-pass answer is never. So we are very probably looking at a global recession with no end in sight.” Miserable stuff, eh?  And so wrong.

So what happened ? Much to the surprise of frequently-quoted pessimistic experts stock markets have risen sharply. The Dow Jones Index is up by more than 83%.

But what is the Dow?  How is it calculated?

Introduced in the late 19th Century it takes its name from its ‘inventor’ Charles Dow and his statistician partner Edward Jones. Its full name included the word ‘Industrial’ to recognise the US economy of the time.

If you look up Wikipedia you’ll discover it’s an Index of 30 stocks chosen by committee and the constituent companies are changed when they fancy it from time to time to recognise changing fortunes and an evolving economy. Original companies included the Tennessee Coal, Iron and Railroad Company but that was removed (for obvious reasons) many years ago.

So the Dow comprises 30 stocks chosen to represent the US economy. The Index is weighted by share price not the capital value, so it’s simply the sum of the stock prices of the companies divided by a factor selected by a committee who also select and change the component companies. My dad used to say that a camel is a horse designed by a committee, and I have to concede that the closer you look at how the Dow is made up, that is an apt description.

Did you know that only 16 companies in the present Index have been there since before 2008 ?  Did you know that over last 30 years there have been no fewer than 32 companies selected to join the Index with the same number kicked out. So the Index to me is like the hammer proudly owned by the local retiring joiner interviewed by a journalist and when asked if he’d seen many changes over his long career, replied…. “They don’t make tools like they used to. See this hammer? I’ve had it for over forty years. Mind you it’s had two heads and three shafts in that time”

Apple, one of the most iconic and successful US businesses, was only chosen by the committee in 2015. Amazon has never been in the Dow. IBM was chosen in 1979 after being dumped out 40 years earlier. It’s been calculated that had IBM stayed in the Index, the Dow would be 4000 points higher today. Goodness knows how much higher it would’ve been had a more forward looking committee chosen to include Amazon and Apple 10 years ago never mind Starbucks or Facebook.

Finally, just to convince you that spending anytime wondering what the Dow’s up to when considering your portfolio strategy is a waste of time, here’s how the Index is calculated:

“To calculate the Dow, the sum of the stock prices of all 30 stocks is divided by a divisor- since 3/6/2021 the divisor is 0.15188516925198.  And every $1 change in the stock price in a particular stock within the average equates to a 6.583921293467330 point movement.  

Got that? Thought not.

©2022 Alan Steel Asset Management Limited is authorised & regulated by The Financial Conduct Authority. Please note that the Financial Conduct Authority does not regulate some forms of tax advice. Company Registration: SC58014

You should remember that the value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.

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