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Equity investors can justifiably cheer the new record high for the Dow Jones Industrial Average. The broader market has shared the Dow’s recent momentum. Hopes of a soft landing for the economy have conspired with easing oil prices to improve sentiment. It is, however, a shame the Dow has become so unrepresentative of the US market.

The committee that chooses its 30 stocks leans towards industrial companies, except when the likes of Microsoft get too big to be ignored. As a result, the Dow did not participate in the technology boom of the late 1990s to the same extent as the broader S&P 500 index, let alone the technology-biased Nasdaq Composite. Nor did it fall as far from its early 2000 peak. The S&P 500 remains well short of its record, while the Nasdaq is languishing more than 50 per cent below its high. With technology stocks still out of favour, the Dow’s composition and less demanding comparisons help explain why it has regained its peak first.

But that obscures the Dow’s flaws. The biggest factor in its resurgence since 2000 has been Caterpillar. The construction equipment maker was not even in the top 15 most influential stocks driving the S&P 500. This illustrates the Dow’s biggest absurdity – its share price weighting. Caterpillar’s share price is similar to that of ExxonMobil, the leading positive points contributor in the market capitalisation-weighted S&P 500. Caterpillar is up more than 150 per cent to ExxonMobil’s 50 per cent. But the oil giant is still worth almost 10 times as much. The Dow’s narrowness is problematic too. Cisco Systems, the biggest downer for the S&P 500 since 2000, is not even in the Dow.

The venerable Dow may be the grandfather of stock indices. But investors should expect later generations of indices to be more in touch with reality.

Copyright The Financial Times Limited 2017. All rights reserved.
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