Dow Jones: A Relevant Benchmark or a Relic of the Past?

Is It Time to Move Beyond the Dow as a Market Reference?

Those primarily observing the S&P 500 might not perceive the market's decline as significant as conveyed by the DJIA's daily losses during this extended downturn. Historically, the DJIA, SPY, and QQQ have often moved together. However, this recent divergence raises questions about which index best reflects market performance. Should the media and investors rely on the DJIA, which encompasses only 30 companies, or the far more extensive S&P 500 index when discussing market performance?

Is the DJIA Too Narrow of a Measure of the Markets?

As a price-weighted index, the DJIA consists of only 30 stocks, representing some of the largest and most established companies in the United States. This structure means that higher-priced stocks have a disproportionately large effect on the index value. A significant drawback is that if a company experiences a stock split, it can drastically shift the DJIA's calculated value. Many critics suggest that the DJIA is no longer a reliable gauge of the broader financial market or the U.S. economy.

The DJIA has a rich history, established in 1896, starting with 12 stocks, then expanded to 20 in 1916, and finally to 30 in 1928. Since then, the index has consistently maintained 30 components. Remarkably, none of those original stocks remain listed today, emphasizing the evolving nature of the markets. While the committee responsible for maintaining the DJIA replaces underperformers with new stocks, a case can be made that increasing the number of stocks in the index would yield a more comprehensive market representation.

Is the S&P 500 Index the True Benchmark for the U.S. Markets?

The S&P 500 index was created by Standard & Poor’s in 1957 with the aim of tracking the 500 largest public companies in the United States. This broader selection allows for a more accurate depiction of the U.S. economy, detailed across 11 sectors and 24 industries. Given its wide acceptance, the S&P 500 is viewed as the most accurate benchmark index, which is reflected in its status as the most heavily traded index futures contract globally.

Moreover, the S&P 500 serves as the benchmark for measuring investor and fund manager performance. Funds frequently compare their results against this index. Unlike the DJIA, which is price-weighted, the S&P 500 is a market capitalization-weighted index, meaning that larger companies exert more influence on its value. Notably, the so-called Magnificent Seven stocks—major players in the tech sector—account for about 30% of the S&P 500's total valuation.

While expanding the DJIA might provide a better reflection of the financial landscape, the S&P 500 index remains the top choice for adequately assessing the U.S. economy and stock markets.

For a balanced perspective, investors can also look at the S&P 500 Equal-Weight index available through Invesco S&P 500 Equal-Weight ETF, which shows significant performance differences. As of December 20, 2024, the SPY has posted a respectable gain of 24.4% compared to the RSP's 12% year-to-date increase.

Conclusion

As the market evolves, it may be time to reconsider the relevance of the Dow Jones Industrial Average as a primary benchmark. The S&P 500 offers a broader, more representative snapshot of the U.S. market, making it a more reliable reference point for investors and analysts alike.

DowJones, S&P500, Market