Industrials Revolution?

We've noticed a lot of press lauding recent all-time highs of the Dow Jones Industrial Average. Last Friday's commentary section of the Wall Street Journal featured an essay from economist Jeremy Siegel defending the "venerated" index.

His reasoning is based on a truly confounding notion: because stocks in the Dow are chosen by committee, the index is superior to cap-weighted indexes. We quote: "Despite widespread pressure, the Dow wisely excluded these and other tech stocks (particularly Cisco, which for a time was the world's largest company by stock market value) from the industrial average."

Wisely? We cannot understand this reasoning. Indexes are constructed precisely to create an objective, passive representation of the market in a specific category such as a region or industry. They are not used to make active decisions on what's "wise" to include. This isn't indexing at all; it's active portfolio management.

The Dow is a poorly constructed index. It's price-weighted and dominated by a few non-representative stocks. The Dow is currently skewed heavily to Consumer Staples and Industrials. The index's biggest weights are: Boeing (5.6%), IBM (5.6%), Altria (5.3%), 3M (5.1%) and Caterpillar (4.6%). These five stocks comprise 26% of the index. The MSCI World and S&P 500, both cap-weighted and currently below their all-time highest levels, are superior representatives of the broader global and US markets respectively.

If you want to see how stocks are doing according to the Dow's committee, watch the Dow Jones Industrial Index closely. But if you want to know how the markets are really performing (the fundamental reason an index exists!), follow a cap-weighted index like the S&P 500 or the MSCI World.