The Dow Jones — a flawed measure but with a rich history

A visual biography of the all-American average as it breaks 20,000

The Dow Jones is the most famous stock market measure in the world, but its full title — the Dow Jones Industrial Average – suggests reasons why it is no longer regarded as a benchmark by market professionals.

The Dow was originally composed of 12 “smokestack stocks – names from the American industrial expansion of the late 19th century, such as Tennessee Coal & Iron and National Lead. The index increased to 20 stocks in 1916 and expanded further in 1928 to its current 30 members, but it has become increasingly more difficult to adequately represent a modern, diversified market with only 30 companies. By contrast, the Standard and Poor’s composite index has 500 members. 

The Dow is weighted only by the prices of its constituent companies — hence “average”. This means companies with high share prices exert more influence than other constituents, which can be larger by market capitalisation. Goldman Sachs, the highest priced stock in the Dow, currently at about $245 a share, has accounted for more than a quarter of the change in the Dow since November’s US presidential election (see chart). The S&P composite, like most other headline stock market indices, is weighted by market capitalisation. 

Consequently, Wall Street professionals have moved away from the Dow. Over $2tn of invested funds directly follow the S&P, with less than $40bn riding on the Dow.

That said, milestones such as 20,000 still attract a great deal of interest. Why?

Essentially because the Dow’s longevity and consequent familiarity outweigh the problems for those working in the market. The Dow is synonymous with the US stock market: “What did the market do today?” is interchangeable with: “What did the Dow do today?” in the public mind.

The Dow pre-dates the Federal Reserve. Its longevity is impressive, covering 21 presidents, 23 recessions (and recoveries), and six major wars. Its long history also means it is the only way to compare the fall in the markets in 2007-2009 with the drop seen from 1929 onwards. This was also seen in increased interest in the FT’s own 30 index, long since replaced as a benchmark of the UK market by the All-share and then the FTSE 100.

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