Note: Almost four years ago, the Dow inspired me to start a series of posts explaining economic terms and concepts from a Christian perspective. It’s fitting then that the Dow is also motivation to relaunch this long dormant feature (over the past two days the Dow has suffered the worst point decline in history).
I call it the “Dow Conundrum.” At least once a week, for as long as I can remember, I’ve heard about the Dow Jones Industrial Index (DJIA). But I didn’t really know what it meant or why it mattered. So a few years ago, I decided to ask a range of people, from entrepreneurs to teenagers, if they had heard of the DJIA (all had), if they knew what it measured (most knew it had to do with the stock market), and why it mattered so much that it was mentioned in news reports every day (none of them – not one — could explain its significance).
And it wasn’t that I picked a particularly economically illiterate sample for my experiment. A couple of years ago Adam Davidson of NPR’s Planet Money wrote,
Turn on the news on any given day, and you’re likely to hear about the Dow Jones industrial average. It is the most frequently checked, and cited, proxy of U.S. economic health. But a lot of people — maybe most — don’t even know what it is. It’s just the stock prices of 30 big companies, summed up and roughly averaged. That’s it.
And what does the daily movement of this number have to do with the lives of most Americans? Not much.
I’d like to think I have an above-average grasp of business and economics. I’ve taken economics classes in high school, college, and grad school. I’ve started businesses and have an MBA. So when I say I didn’t really know what the Dow Jones meant or why it mattered, I mean I didn’t know until 2012 at the age of 42. I had spent my entire life not knowing because I was too embarrassed to ask. I assumed other people must know and so I didn’t want to reveal my ignorance.
The truth is that most people don’t understand basic economic concepts. And even most of those who can define economic terms because they had them on an Econ 101 exam do not truly understand their significance (or, in the case of the DJIA, their relative insignificance). This is a problem for most Americans but an especially acute problem for Christians. Before we can “seek the welfare of the city” (Jeremiah 29:7) we have to know what economic concepts mean and how they should be applied. We simply can’t be effective in our role as citizens when we don’t understand economics.
To help close that economic knowledge gap, I’m restarting this monthly series that will attempt to define and explain a range of economic terms from a Christian context. The purpose is not to present a theology of economics, but simply to provide a basic level of understanding that will help Christians think more clearly about how to apply their faith commitments to economics and public policy.
The three broad categories in this series are “What Every Christians Should Know” (i.e., most all Christians need to understand these), “What Most Christians Should Know” (i.e., more advanced concepts that are useful, but not essential, for Christians to know), and “What Some Christians Should Know” (i.e., concepts applicable mostly to Christians in particular fields or vocations, such as business, banking, government, etc.). See the end of this post for the most recent entries.
The Term: The Dow Jones Industrial Average (aka DJIA, Dow Jones, or simply, the Dow)
What it Means: The Dow is the second oldest stock market index, a measurement of a section of the stock market. As its name implies, the DJIA was initially a measure of the industrial sector of the stock market. But as the structure of the American economy has changed, the components of the Dow have also changed. Since its inception in 1896 the companies tracked by the Dow (named after Charles Dow and Edward Jones) have changed 51 times.
The following companies currently compose the Dow (the number in parentheses notes when it was added to the index); 3M (1976), American Express (1982), Apple (2015), Boeing (1987), Caterpillar (1991), Chevron (2008), Cisco (2009), Coca-Cola (1987), DowDuPont (2017), The Walt Disney Company (1991), ExxonMobil (1928), General Electric (1907), Goldman Sachs (2013), The Home Depot (1999), IBM (1979), Intel (1999), Johnson & Johnson (1997), JPMorgan Chase (1991), McDonald’s (1985), Merck (1979), Microsoft (1999), Nike (2013), Pfizer (2004), Procter & Gamble (1932), Travelers Companies, Inc. (2009), United Technologies (1939), UnitedHealth (2012), Verizon (2004), Visa (2013), and Wal-Mart (1997).
Why It Matters: The Dow is indisputably the most frequently cited stock market index. And yet there are many people (I am one) who think it should be discarded because it is a misleading, outdated relic.
There are two main problems with the Dow. The first is that many people confuse “the stock market” with “the economy,” and assume that if the stock market is doing well/poorly then the economy is doing well/poorly. This isn’t the fault of the Dow, of course, but the people who cite the Dow rarely offer this clarification. (We’ll discuss this is more detail in a future entry on the stock market.)
The second major problems is that the Dow is often used as an indicator for whether the stock market itself is performing well or doing poorly. Although the Dow is often correlated with the overall stock market, it fails even to be a useful proxy for the entire market.
Here are a few reasons why the Dow is less than helpful for understanding the economy:
The Dow compares apples to oranges — You’ll often hear that the Dow “hit a new historical high” or reached a “dropped to a new historical low.” This might make sense if the Dow had tracked the same stocks throughout its history. But it doesn’t, which makes “historical” markers irrelevant. Financial commentators also refer to the Dow’s “point highs” and “percentage highs” which are also different.
The Dow uses a price-weighting system — This is a complicated factor to explain, but here’s a simple summary: the Dow gives more weight to higher-priced stocks and doesn’t take into consideration other relevant factors, such as the relative size of the industry or the size of the companies in the Dow. Companies like 3M and Home Depot have more of an influence on the Dow than larger companies like Intel and Coca-Cola. As Jeff Sommer says,
Imagine that you are creating a food index based on all of the items you have bought in the last year.
You purchased one jar of caviar and 1,000 cans of tuna fish. In a price-weighted index, caviar will have the biggest overall impact because it’s the most expensive item you’ve bought, even though you spent far more money on tuna. The rise and fall of caviar is the powerhouse that controls your price-weighted food index, even if you never buy caviar again in your life.
The Dow excludes some of the largest companies in America — If you wanted to track the health of American companies you might want to know what the largest are doing. The Dow, however, excludes many of the largest companies. The Dow doesn’t track the second (Alphabet, the parent of Google and YouTube), fourth (Amazon), fifth (Berkshire Hathaway), or eighth (Facebook) largest companies in America. In fact, the largest company in the U.S.—Apple—was only added in 2015.
For all these reasons, the Dow should be abandoned as the primary index used to track the market. Instead, we can use more relevant trackers such as the S&P 500 (an index based of the 500 largest public companies), the S&P Composite 1500 index (an index that covers 90 percent of the market capitalization (i.e., the aggregate valuation of the company based on its current share price and the total number of outstanding stocks) of traded U.S. stocks), or the CRSP U.S. Total Market Index, which represents nearly 100 percent of the market for publicly traded U.S. stocks.
What Every Christians Should Know
What Most Christians Should Know
What Some Christians Should Know
(Entries to come – check back soon.)
If you have suggestions for terms or concepts to be covered in this series, send them to me at [email protected].
A note on bias: Economics is prone to a range of biases, from the moral to the political to the personal. Since I’m writing this series for a think tank dedicated to the study of religion and liberty, there will obviously be a particular point of view. I make no apologies for the biases I hold (which could be summarized as an “Acton bias”) but I do intend to try to present the concepts neutrally whenever possible.