Tuesday, March 31, 2009

Why the Dow Jones doesn't cut it

Having recently been exposed to the US media over an 8 week period , a depressingl ylong amount of time, I have more than a few gripes and grievences to write about. First and foremost in my mind is the over usage of the "Dow Jones" index to act as some sort of one-stop-indicator, that shows, at any given time, how the US economy is doing.

Flicking from channel to channel (and there are alot of them) I noticed that nearly every news channel had the bottom right corner of the screen devoted to telling me, and anyone else who cares to look, how the Dow jones index is doing for that day. Furthermore, many news broadcasts would begin by stating how terribly or wonderfully the "Dow" had performed that day, and how this was either an obvious sign of Economic recovery, or depending on the station's political allegence (like Fox news) an obvious sign that Obama's economic plans were good for nothing.

It occured to me that although this figure is being widely peddled as "the economy" to Americans, that very few of them would actually know what the Dow actual was, and much less what companies comprised the index.

So I went about asking a few people if they knew what the Dow was, the answers I got ranged in complexity:
  1. "Its the economy"

  2. "Its the Stock Market"

  3. "Its an index of stock prices"

  4. "It's an index of all the american shares trading on the stock market"

Before I did a little research on the matter myself I would have thought that statement number 4 would have been fairly accurate, however, with the help of a few online sources I discovered that I was wrong. The "Dow Jones" as quoted in financial newspapers, tv broadcasts etc, is actual an index or average of the 30 of the largest and most widely held public companies in the United States.

Statistically, when trying to analyse average performance of a high number of figures, it is important to consider what effect the "outliers", or extreme values, are having on the end figure. So taking into account ONLY the 30 largest companies in a given country seems on odd way to gauge economic strengh, because in effect it is an index comprised solely of outliers (of a sort).

And if having a mere 30 share prices wasnt bad enough, things get a little worse:

  • The index calculates the its value based on the Dollar change in share prices, not as you might expect in % terms. Therefore if StockA - valued at $40 rises 1 dollar, and StockB - valued at $15 falls falls 1 dollar, the index will register no change whatsoever.

  • As of March 2009 the Dow includes companies such as Bank of America, General Motors, Pfizer, Citigroup etc, companies how are in very volatile industries, and as a result who's stock price changes might falsely shape the day's Dow outcome.

I think that although I complain about this over simplification, there does need to be an easy way to describe how the economy is doing. The religiously revered Dow Jones doesnt seem to be the answer though. The S&P 500, which monitors the changes in, you guessed it 500 stocks, is a much better measure, however is used by the US/most media as a second class figure. Luckily for me someone who knows much more about the matter agrees with me. David Leonhardt from the NY times agress the S&P "absolutely would be a better measure" adding "there really is no good reason for the rest of us to use the Dow as the main benchmark of the stock market."

So, if you are smart, which of course you are, you should listen to me and David and view the Dow Jones as what it is, 30 companies and A not THE measure of the stock market.

Sunday, March 29, 2009

Looking vs. Seeing

Back in town

Well once again I have left this blog in a bit of a dry spell for quite a long time, but I suppose I have a reason that could be seen as acceptable. For the last 2 months I have been having a bit of a wander around North America, and I was so consumed with exploring/sitting around/being lazy that I didnt contribute much to this blog.

Now that I am back I hope to be writing a little more regularly to the blog, and soon normal amounts of complaining will resume.

Below is a Goolge Earth map of my little journey.