Donald Luskin has a great article about why a record-setting Dow is irrelevant.

The Dow is really nothing more than a random collection of arbitrarily selected stocks — and just 30 of them. It hardly represents the overall equity market. The much broader S&P 500 is far more representative, and it behaves quite differently as a result. The proof? Easy: The S&P 500 is nowhere near all-time highs, while by sheer luck the Dow just happens to be.

The stocks in the Dow are all tried and true — and tired — blue chips. They don't come close to representing the real growth potential of the American economy. The Russell 2000 Index, which covers smaller companies exclusively, does a much better job of capturing the spirit of risk-taking that is the heart of investing. And it's been making all-time highs for most of the last two years. ...

And have you ever wondered how the Dow is calculated? The movements of the index each day are calculated based on the assumption that you own an equal number of shares of each of the 30 companies. Is there anyone in the world who actually invests that way? I hope not.

Equal share numbers mean you haven't thought about how many dollars you want to put at stake in each stock. A hundred shares of Microsoft (MSFT: 28.29, -0.23, -0.8%) are worth $2,740. 3M (MMM: 76.40, +0.87, +1.2%) is a higher-priced stock, so 100 shares is worth $7,460 Do you really want to own about three times as much 3M as you do Microsoft? Maybe — but if so, you should have a better reason that just because the number of shares is supposed to be the same.

Since the dollar exposure to stocks in the Dow is a function of their price, the movements in high-priced stocks like 3M influence movements in the index more than the same percentage movement in low-priced stocks like Microsoft. Is there any rational reason why 3M should move the average more than Microsoft?

And suppose that one day 3M does a big stock split, so that its stock price falls from being three times that of Microsoft to only one-third that of Microsoft. Now, for no better reason than the stock split — an economically meaningless event — suddenly Microsoft becomes the one with three times the influence on the movement of the Dow.

And so forth and so on... but he doesn't mention the psychological effect the number has on so many people, thus taking on importance through attribution. But anyway, he's right.

If you want to keep good track of how American markets are doing, get familiar with the S&P 500 and the Wilshire 5000. Watching the rest of the world can take a bit more doing.



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