Mark Hulbert Whistles Past the Graveyard

In his column in yesterday's New York Times business section (Strategies: "The Road Back from the '29 Crash Wasn't So Long After All"), Hulbert writes that, although the Dow didn't match its 1929 peak until 1954, investors who bought and held the Dow at its 1929 peak would have been made whole in real terms four and a half years later, thanks to double digit deflation and double digit dividend yields. Of course, today we have a fiat currency and a Federal Reserve committed to fighting deflation, and dividend yields on Dow stocks average in the low single digits, so Hulbert's example doesn't seem terribly apposite.

With No Changes in Eighty Years, Where Would the Dow Be Now?

That's a question John Mauldin addresses in this week's edition of his Frontline Thoughts newsletter, "Deep Inside the Dow" (PDF):

The Dow Industrials was expanded to 30 names from 20 on October 1 of 1928. Today, only nine names of the original 30 remain in the Dow. The committee at Dow Jones has replaced the other names as the companies grew out of favor, were merged into other stocks, were considered too small, or the committee felt that other companies better represented the industrial prowess of the US economy.

[...]

Thinking about the Dow, I wondered how much the committee had helped or hurt the Dow performance over the last 80 years. What if we went back to the original 30 stocks and simply bought them and held them until today? Good, bad or indifferent, what would the results be?

Mauldin gets this answer from Rob Arnott of Research Affiliates:

If Dow Jones hadn't tinkered with the index, the 30 companies would have merged or failed their way down to just 9 survivors. Of the 21 companies in the original 30 that are now gone, 20 disappeared through M&A, some were replaced by successor firms and others not, and only one (Bethlehem Steel) failed outright. But this no-fiddling index would have topped out at just over 30,000 in October 2007 and would have finished 2008 at 14,600.

The performance of that non-tinkered with index is represented by the second-from-the-top line on the above graph, which comes from Mauldin's newsletter. The top line represents the performance of the same non-tinkered with stocks if they had been equal-weighted instead of price-weighted, as the Dow is.

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.

"Dow'd but not Out"

Just got an e-mail from Seattle restaurant company Chow Foods, advertising the promotion below. I've only been to one of their restaurants, The Five Spot, but it was excellent: great breakfast, and some of the strongest coffee I've ever had.

Dow'd But Not Out

As a token of our appreciation to our loyal customers, on Thursday, October 16^th, between 5-10pm, CHOW Foods is executing a short term Main Street bailout plan far more delicious than the one the goofs in congress passed last week.

To make sure the Dow doesn't get you down, on Thursday night only, we're pricing our menu based on the close of the market on the 16th. The lower the Dow closes on Thursday, the less your entrée costs--no food on the menu will be priced more than the Dow. If it closes at 8300 (gulp!) then you won’t pay any more than $8.30 for any item on our food menus.

If Chowin’ on the DOW isn’t enough to whet your appetite, keep in mind that our house red & white wine, draft beers and well drinks will be priced at the NASDAQ close for the day.  If it dips to 1250, then our depression era pricing on these libations will be just a buck twenty five!

Stop by for dinner and drinks between 5 p.m. and 10 p.m. at any of our joints as we match the economy cent for cent. Menu prices will be set according to the markets close, so for one night, forget about the size of your 401k and CHOW down on our nickel.

Get your wallet off your mind and join us on October 16^th at your local CHOW restaurant and enjoy a taste of the good life for a little bit less. For a full list of restaurants or to browse our menus see www.chowfoods.com

AIG, Merrill Lynch, and the DJIA: Questions

Someone on CNBC asked an interesting question of NY State Insurance Dept. Superintendent Eric Dinallo this morning: might AIG have avoided this crisis had Elliot Spitzer not forced out long-time AIG chief Hank Greenberg? Dinallo, who was nominated to his position by Spitzer during his scandal-truncated governorship, declined to speculate.

Two questions I haven't heard anyone speculate on yet (though I'm sure I'm not the first person to think of this): Is there any chance AIG will stay in the Dow Jones Industrial Average after this? If not, what companies will replace AIG and Merrill Lynch in the DJIA? It will be interesting to see if the editors of the Wall Street Journal use this opportunity to replace one or both of these companies with non-financial companies, to reflect the contraction of the financial sector as a percentage of the economy.