Article 4 of 200
FORTUNE Investor
Could the Dow Become Extinct? The venerable index still means
"the market," but it's short on tech stocks. Some Wall Street pros
just ignore it.
Katrina Brooker
02/15/99
Fortune Magazine
Time Inc.
Page 194+
(Copyright 1999)
Is the Dow Jones industrial average still relevant? Just asking the question
feels insolent, even indecent. After all, this is the grand old lady of indexes,
and she is not to be lightly dismissed. For more than 100 years the Dow has
been the stock market. It's what the anchor on the six o'clock news refers to
when talking about the economy. It's what flashes incessantly across Times
Square's ticker, makes headlines around the world every time it moves, and
is the subject of endless debate in magazine columns and on talk shows. Will
it crash in 1999? Can it reach 10,000? But for more and more investors the
real question is, Does the Dow matter? Why should anyone pay attention to a
century-old purported yardstick of American business that largely ignores
technology companies--arguably the most important sector of the modern
economy? Increasingly, many stock market pros don't.
Created in 1896 by publisher Charles Dow and passed down year after year
from one editor of the Wall Street Journal to another, the index we know
today consists of the 30 U.S. stocks that--the current editors judge--reflect
the state of the stock market now. There is no secret formula for
determining what goes into the Dow--no Coke recipe in a vault, no
well-guarded list of ingredients for Big Mac sauce. Nor does anyone know
why it is now limited to 30 names. (It originally had 12.) In fact, there are
really no rules governing the list at all. Contrary to popular myth, its
companies can trade on any stock exchange (not just the NYSE). They are
not required to be any particular size or to fit into any specific industry mix.
The Dow is, simply, whatever the Journal's editors think it should be.
And how do the editors make these decisions? "{An editor} could run into
somebody in the men's room and get the ball rolling that way," says John
Prestbo, the editor at the Journal who oversees the index. But there is one
hard and fast rule: "The Dow is not, has not been, nor will it be a hot-stock
index," insists Prestbo. "Otherwise we'd have a bunch of Internet stocks in
it."
Fair enough. Amazon .com probably doesn't belong. But not all tech
holdings are Internet hotshots. The only two obvious tech names on the Dow
are IBM and Hewlett-Packard. Prestbo offers up Kodak as another. "Its
{tech} role--this is going to sound corny--is to find its footing in the
digitized world," he argues.
For most investors, that's a stretch. "I'd have to debate that one," says
Marshall Acuff, an equity strategist at Salomon Smith Barney. "They should
get Intel in there." Moreover, because of the dearth of tech companies, the
Dow rose a mere 16.1% in 1998--far less than broader benchmarks such as
the S&P 500 (26.7%) and Nasdaq (39.6%).
Years ago, before the advent of high tech, the Dow--with its roster of
household names like McDonald's and Coke--was a truer measure of the U.S.
economy. Over the past 30 years its annual returns have closely tracked the
S&P's--12.3%, vs. 12.7%. Prestbo insists that the lag now is simply a
standard case of indexes flip- flopping against each other, not a reason to add
tech stocks. "I've got news for {critics}: There's still an industrial sector in
this country that still employs a lot of people," he says.
The Dow does get updated now and then. In March 1997, HP, Johnson &
Johnson, Travelers, and Wal-Mart replaced Bethlehem Steel, Texaco,
Westinghouse, and Woolworth. But that in itself shows the problem: What
was Bethlehem Steel doing on a list of just 30 stocks that's supposed to
mirror the U.S. market three years short of the 21st century? And since so
few companies can make the list, each has an outsized influence. The trouble
is, investors say, some older stocks like Goodyear and Sears that are no
longer industry leaders probably shouldn't have that kind of sway over the
market. Anyway, with a market this big, the Dow's list of names is too short.
"I mean, 30 stocks?" groans Stanford University professor and Nobel
laureate William Sharpe. "How can that represent the market?"
To find out what is really going on, investors are increasingly turning to
other yardsticks--the S&P, Nasdaq, the Russell 2000, the Wilshire
5000--often mixing them to create their own customized measuring tools.
The Dow is just one of many. "I glance at it--force of habit," says Ken
Fuller, an analyst at T. Rowe Price, who watches 15 indexes a day. Even
more dismissive is Peter Canelo, an investment strategist at Morgan Stanley.
"I don't really care what the Dow is doing," he says. "They were all great
stocks 40 or 50 years ago." But for the ultimate in Dow dissing, consider Jon
Schoolar, a growth fund manager at AIM Management, who doesn't even put
it on his computer screen: "I have a residual memory of the Dow, but I don't
pay much attention to it anymore." Even some ordinary investors have lost
faith in the index. Says Hugh Folk, a 68-year-old private investor living in
Honolulu: "I look at what Dell and Microsoft are doing."
Despite its problems, the Dow is not about to disappear. It is still the most
widely recognized index in the world. "When clients call and want to know
how the market's doing, I give them the Dow," says Robert LaFleur, an
equity strategist at Northern Trust.
Indeed, two years ago the Dow even launched a second career as an index
fund, licensing its name to mutual funds. So far there are just three Dow
funds, with total assets of $134 million (compared with 93 S&P index funds
containing $170 billion in assets). One consequence is that the index has a
new crop of defenders. Frank Petrilli, whose company manages the
Waterhouse Dow 30 fund, gets positively fierce when asked if the Dow is
decaying. "Who told you that? I've never heard anyone say that," he snaps.
Unless the Dow undergoes some overdue renovation, chances are he'll hear it
more and more.
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