James Bianco on the Distortions of the Dow

James Bianco makes interesting points about the impact of the current inclusion of sub-$10 stocks in the Dow Jones Industrial Average. Via Cumberland Advisors:

Comment - The Dow Jones Industrial Average (DJIA) is a price weighted index. The divisor for the DJIA is 7.964782. That means that every $1 a DJIA stock loses, the index loses 7.96 points, regardless of the company's market capitalization.

Dow Jones, the keeper of the DJIA, has an unwritten rule that any DJIA stock that gets below $10 gets tossed out. As of last night’s close (January 20), The DJIA had the following stocks less than $10...

Citi (C) = $2.80
GM (GM) = $3.50
B of A (BAC) = $5.10
Alcoa (AA) = $8.35

If all four of these stocks went to zero on today's open, the DJIA would lose only 157.3 points.

The financials in the DJIA are...

Citi (C) = $2.80
B of A (BAC) = $5.10
Amex (AXP) = 15.60
JP Morgan (JPM) = $18.09

If every financial stock in the DJIA went to zero on today's open, it would only lose 331.25 points, less than it lost yesterday (332.13 points).

If you want to add GE into the financial sector, a debatable proposition, then:

GE (GE) = $12.93

If the four financial stocks above and GE opened at zero today, the DJIA would only lose 434.24 points.

The reason the DJIA is outperforming on the downside is the index committee is not doing it job and replacing sub-$10 stocks and the financials are so beaten up that they cannot push the index much lower.

So what is driving the index? The highest priced stocks:

IBM (IBM) = $81.98
Exxon (XOM) = $76.29
Chevron (CHV) = $68.31
P&G (PG) = $57.34
McDonalds (MCD) = $57.07
J&J (JNJ) = $56.75
3M (MMM) = $53.92
Wal-Mart (WMT) = $50.56

For instance if all the sub-$10 stocks listed above, all the financials listed above and GE opened at zero, the DJIA loses 528.63 points. To repeat if C, BAC, GM, AA, JPM, AXP and GE all open at zero, the DJIA loses 528.63 points.

If IBM opens at zero, it loses 652.95 points. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE and Alcoa combined.

The DJIA is not normal as the Index committee is not doing their job during this crisis, possibly because of the political fallout of kicking out a Citi or GM. As a result, this index is now severely distorted as it has a tiny weighting in financials and autos.