Scary Dow has long since lost its relevance

The Baltimore Sun

The poor Dow Jones industrial average. It's under attack again, and not just by fearful investors dumping shares and driving it toward 7,000.

"Some critics say the Dow is an inherently flawed gauge of overall market activity," The New York Times reported in 1986.

They're still saying it, only louder. Poorly designed, more than a century old, the Dow is less relevant than ever. For all the alarm it is causing, the diving Dow actually understates the fear in the economy and the stock market.

Like the old Holy Roman Empire, the Dow manages to belie every component of its name.

It's not industrial. Not with Disney and McDonald's as members. It's not an average. It ought to be labeled after the appropriately mercurial owner of News Corp., which bought the rights to the indicator a year ago, not the sober Charles Dow and Edward Jones:

The Inaccurate But Ancient Rupert Murdoch Index Of Famous Companies, Many Of Which Are Doomed.

That's more like it.

Like a bad mutual fund, the Dow has a habit of buying high - adding companies at their trendy zenith - and expelling them only when their stock is practically worthless.

The latest shuffle came in September, when index honchos hurriedly kicked out American International Group, which had been brought low by bond-insurance bets.

AIG was replaced by Kraft Foods, showing that the Dow designers wanted to get as far from the hated financial sector - the one they previously loved - as possible.

"Are there credit default swaps on cheddar and Velveeta?" one imagines them saying. "No? OK, Kraft, you're in."

AIG was admitted in 2004, when it was obvious to everyone that such highly indebted, deregulated financial giants were the promising future of American capitalism.

Index managers believed megafinance was so important they added Bank of America a year ago. The Dow already included American Express, Citigroup and JPMorgan Chase, none of which, it's safe to say, has done the indicator any favors recently.

The Dow also includes General Motors, which has fallen from $25 to $2. It added Microsoft and Intel in 1999, near the peak of the technology bubble.

But buying high and selling low isn't the index's main challenge. After all, it's supposed to trace the downs of the market as well as the ups. The larger issues are the size of the membership and the way the Dow is calculated.

Stock indexes are supposed to be passive, reflecting the behavior of the whole market or large chunks of it. The Dow has only 30 members, however, chosen by fallible humans. That small sample means it frequently diverges from what's going on - on balance - among large, publicly traded U.S. corporations.

The Dow's primitive innards are another flaw. They didn't have computerized spreadsheets in 1896, when Mr. Dow sat at his roll-top desk and calculated how companies such as U.S. Rubber and American Sugar were doing.

As a consequence, his index traces share prices, not the total value of a corporation's stock. Share prices are easier to tabulate. But they represent an arbitrary fraction of the whole, so they can be misleading.

Every dollar change in every stock moves the Dow by the same amount, whether the stock is Chevron at $65 or Citigroup at $2. So the recent implosion of Citi, General Motors, General Electric, Alcoa and Bank of America, whose share prices were already pretty low, has had relatively little effect on the index.

That's partly why the Dow is down only 37 percent from its August high, just before things collapsed, while the Standard & Poor's 500 index is down 41 percent. The S&P; 500, which adds up all the prices of all the shares of its members, is a much better gauge of how Big Business is doing.

Old habits die hard, however. Just as we report on Groundhog Day every year, the news media will keep covering the Dow. (It fits easily in headlines.)

Check out Punxsutawney Phil. But be sure to pay attention to the National Weather Service, too.

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