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Friday, April 02, 2004

Not your grandfather's Dow Jones

If you talk to the average stockbroker, or even regular office guy with a 401k, they'll tell you how stocks always go up over time; just look at the history of the Dow Jones Industrial Average. Forget the effects of inflation, what they also neglect to factor into their stunningly ignorant equation is that the Dow is not the Dow of yore. It's barely even the Dow of yesterday.

The century-old Dow Jones Industrial Average was reshuffled yesterday in a way that reflects the strains from the recent recession, globalization and information-technology revolution on American businesses. Three venerable but declining companies — AT&T Corp., International Paper and Eastman Kodak — were replaced by three recent winners in today's globe-spanning competition: insurance giant American International Group Inc.; the largest local U.S. phone company, Verizon Communications; and the world's biggest drug company, Pfizer Inc.

Why? Well, according to the managing editor of the Wall Street Journal: "Evolutionary trends in the economy and the stock market — in particular, the rise of financial and health care stocks and "the diminishing relative weight of basic materials stocks" But apparently no one told the traders that they were supposed to explain it in terms that make the average guy's eyes glaze over: "They're putting in much larger companies that have had better results over the last couple of years," said Owen Fitzpatrick, a portfolio manager at Deutsche Bank Private Wealth Management." Yeah, I thought that might have something to do with it.

The 1999 makeover also heralded the ascendance of "new economy" technology bellwethers such as SBC, Microsoft Corp. and Intel Corp., over the "old economy" icons they replaced: Sears, Roebuck & Co., Union Carbide Corp., Chevron Corp. and Goodyear Tire & Rubber Co. Home Depot Inc., a hardware chain store whose meteoric rise has mirrored record growth in home sales and the remodeling industry, also was added to the Dow at that time.

So, if you get rid of the worst-performing ten percent of the index and replace them with fast-growing new companies every five years, you can keep things moving onward and upward forever. It's almost the opposite of the management of the Consumer Price Index, which excludes, through hedonics interpretation, "substitution" or simple exclusion, all the prices that are going up. Are you noticing a pattern here?

Mutating metrics. Interesting times.

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