Dow Jones Musical Chairs - Part 2

I discussed the chopping and changes made on the Dow in Dow Jones Musical Chairs

Mark Hulbert at Marketwatch touches on the same issue: What happens to Stocks added and deleted form the Dow?

According to Norman Fosback, editor of Fosback's Fund Forecaster, the Dow would today be more than twice its quoted level had IBM not been removed in 1939.

Are these examples typical of all changes made over the past 110 years? I don't know, since I have not gone back and calculated the returns of all stocks that were added or deleted to the Dow subsequent to its creation in 1896. But I wouldn't be surprised if the average deleted stock has outperformed the average addition.

That's because companies that are added often are coming off a period of dynamic growth. A company that is substantially out of favor typically does not get added. This skews the Dow towards the large-cap growth sector of the market, which historically has underperformed smaller stocks and issues that are closer to the value end of the value-growth spectrum.

Therefore, to follow the Dow's moves is not a very good way to track the performance of the US stock market.

I suggest you rather monitor the Willshire 5000 index, which represents the broadest index for the U.S. equity market. This should give you a better indication of where the market is heading.

Dow Jones Musical Chairs

NEW YORK (MarketWatch) -- With Altria Group Inc. and Honeywell International Inc. booted out, the Dow Jones Industrial Average is now getting a little less industrial and a little more oriented financial and oil, with Bank of America Corp. and Chevron Corp. joining the world-famous blue-chip index.

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FMM Comment: Nadeem Walayat made the following point in his article:

"Don't Bet Against the Dow!".

"Investors should realise one important factor about the Dow 30 stock market index and other similar general multi-sector indices that are made up of a limited number of stocks. The Indices are designed to exhibit the long-term inflationary growth spirals. In that in the long-run the indices will always move to a new high! "

Beware the smoke and mirrors!