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Why the Dow is still a Main Street staple

As the stock market has rallied over the past year, the Dow Jones industrial average has set record after record, surpassing the milestones of 12,000, 13,000 and now 14,000. Which raises the question: Why so much hype over an index with just 30 stocks that has been tossed aside by most investing professionals? By Martin Wolk

Ever since the Federal Reserve stopped raising rates last year, the stock market has been on a roll, with the Dow Jones industrial average smashing record after record. The broader market has been rising, too, as reflected by the Standard & Poor's 500, which finally surpassed the high-water mark set in the tech stock boom of 2000.

But as usual, most of the hype and glory has surrounded the storied Dow average, which has set more than 50 record closing highs in the past 10 months, surpassing for the first time the milestones of 12,000, 13,000 and now 14,000.

Which raises the question: Why so much fuss about an index made up of just 30 stocks out of the thousands traded on the nation's stock markets?

The answer lies in history — and in the clever way its managers have kept the Dow an exclusive club of some of the nation's best-known businesses.

"You can relate to the Dow on a human scale," says John Prestbo, editor and executive director of Dow Jones Indexes. "It's 30 stocks, and it's 30 stocks you've heard of in your daily life, so there is a connection that people can relate to."

For the millions of people who only dabble in investments, 30 is likely closer to the number of securities in their own portfolio, compared with the 500 or even 5,000 in some indexes, Prestbo says.

The Dow is hardly restricted to "industrials" as it was when it was created in 1896 by Charles Dow, co-founder and first editor of The Wall Street Journal. He included such mainstays of the era as American Sugar, National Lead and Tennessee Coal & Iron.

Today's Dow includes giants of finance, retailing, media and technology as well, with names like Boeing, General Motors, Coca-Cola, McDonald's, Microsoft, Wal-Mart and Walt Disney.  The index excludes airlines, freight shippers and utilities, which are included in other Dow averages, but otherwise the 30 stocks represent a good cross-section of the economy.

(For a complete list of Dow components, click here.)

And the Dow industrials are solid. Editors of The Journal, who choose which companies are included in the index, have not made a change since 2004, when they added insurer American International Group, pharmaceutical giant Pfizer and telecommunications provider Verizon Communications. They replaced fading giants AT&T, Eastman Kodak and International Paper.

(The AT&T name recently got back into the index through a back door after the company was acquired by SBC, which then changed the name of the merged company to AT&T.)

By contrast the S&P 500, which ironically is much more closely tied to the fortunes of millions of index-fund investors, is less closely followed on Main Street. While many casual investors know the Dow has been trading near the 14,000 milestone, far fewer are aware of the S&P's current level (about 1,550).

While the Dow is made up of 30 hand-chosen blue-ship stocks, the S&P is compiled in a way intended to emulate the entire U.S. stock market, according to Howard Silverblatt, a market equity analyst at S&P. For example if banks make up 20 percent of U.S. market capitalization, the sector will have the same weighting within the S&P 500. And if regional banks are 5 percent of the total, that will be reflected as well.

“The aim of the S&P 500 is to emulate the entire market, not necessarily do better than the market,” Silverblatt says. “If we beat the overall market, we’re not doing our job."

The S&P is changed frequently, with several changes every month in recent times, adding up to a turnover of about 4 percent a year.

Some of the companies dropped from the index recently include Sanmina-SCI, a maker of industrial components, and PMC Sierra, technology manufacturing companies that are hardly household names. Discover Financial Services and Covidien, a spin-off of Tyco International, are among the recent additions.

The S&P's status as a mirror of the overall stock market is one reason it took so much longer to recover from the bear market that began in 2000. Because booming tech stocks became such a huge part of the overall market, the S&P was forced to include more of them into the index, meaning that it fell harder than the Dow. (Neither index fell as far as the tech-dominated Nasdaq composite index, which remains 46 percent below its 2000 record close of about 5,049.)

Prestbo, of the Dow indexes, says history is another reason people follow the Dow more closely than any other index.

The 111-year-old Dow is considered the first U.S. stock index and is certainly the one with the longest track record. "When the Main Street press needed to tell people what what was going on in Wall Street -- and that was the panic of 1907 and the roaring '20s -- it seized on the only existing index that showed which way the wind was blowing," Prestbo says.

And for such a small index, the Dow still does a pretty good job as a windsock, he noted. On any given day, there is about a 95 percent chance that the Dow moves in the same direction as the broader S&P 500. That is true even though the Dow is a "price weighted" index, meaning that any one of its 30 components could move the index if it rises or falls sharply.

The S&P 500 is weighted by market capitalization, meaning its movement depends largely on what happens to the biggest companies listed in the index.

Because of the Dow’s relatively narrow focus, it long ago fell from favor among professionals, who generally use the S&P 500 or other broader indexes as their main benchmark.

The Dow industrials account for only 25 to 30 percent of the nation’s total market capitalization, compared with 80 percent for the Standard & Poor’s 500 and 98 percent for the Russell 3000, another well-known broad index.

All told about $1 trillion in securities are “pledged” to track the S&P 500, Silverblatt says, compared with just $40 billion that follows the Dow 30 through securities such as the so-called “Diamonds,” an exchange-traded fund.

The vast amount of money riding on the S&P 500 explains why individual share values can rise or fall significantly when a stock is added to or deleted from the S&P 500.

Yet the Dow’s storied history, great brand name and unmatched 110-year track record still make it the best-known U.S. market indicator.

“It’s just embedded,” says Liz Ann Sonders, chief investment strategist for Charles Schwab and Co. “The media and broad public, Main Street, still see the Dow as the market.”