A New High – Now Let’s Move On

3 Oct

As oil falls below a key psychological level of $60/barrel, the Dow Jones Industrial Average hits a new intraday high! If you’ve read previous posts, this is not something that gets me too excited, since at these levels on the Dow, the S&P 500 is still 12% below its all-time high. Let’s do a brief analysis of just how the prices of the stocks in the average can affect the DJIA’s overall returns.

General Motors (GM) is the average’s top performer year-to-date, up 74% and responsible for about 1.7% of the DJIA’s YTD performance. Looking deeper at the Dow’s YTD performance, we can see how the price-weighted average calculation method can affect its returns. Merck (MRK), now a $42 stock, is the second highest contributor after GM – up over 32% year-to-date and responsible for about 0.9% of the DJIA returns. The third largest contributor, Boeing (BA), an $82 stock, is up only about 17%, yet has contributed the same amount as MRK (about 0.9%) to the Dow’s returns. Despite Merck’s returns exceeding those of Boeing by almost double, the effect on the DJIA is the same.

Note that the index in no way tries to overweight undervalued stocks or underweight the overvalued stocks. I don’t know many money managers who determine a stock’s weighting in a portfolio based solely on price.

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