Dow Jones Updates Small Batch Artisanal Stock Index

Traders work on the floor of the New York Stock Exchange on March 6, 2013

Photo by Spencer Platt/Getty Images

If you want to know what’s happening with stock prices, you should look up a properly constructed broad stock market index such as the S&P 500 or the Russell 5000. But America also has a weirdly popular stock index known as the Dow Jones Industrial Average which today announced some important changes to its composition. They’re dropping Bank of America, Alcoa, and Hewlett-Packard in favor of Nike, Visa, and Goldman Sachs. It’s a nice indication of the shifting balance of power in the financial services industry, as well as the ever-growing importance of branding in America’s consumer products sector.

But the real point here is simply that the DJIA, though widely cited by the media, is a somewhat bizarre economic indicator. It’s essentially a small batch artisanal stock index, where a committee of people occasionally decided to change up the composition according to semi-arbitrary criteria.

Or, rather, since they want to preserve the brand value of the DJIA they need to try to hand select the stocks so as the ensure that the DJIA trends will roughly track those of stock indexes constructed by more valid methods. The entrance and exit of firms from the index can be read as an indicator that certain companies or sectors are rising or falling in significance, but it’s a mistake to overread that. The obvious HP replacement, after all, would be Apple—a company that’s broadly in the same industry as HP but is now much more economically significant than HP is. But since the DJIA is price-weighted rather than market-cap weighted companies like Apple that have a very high share price would skew the index too much. So you get no Apple and you get no Google. But you still need to hand-select a basket of firms that will prevent the DJIA from diverging too much from stock indexes that do include companies like Apple and Gogle.

Incidentally, people sometimes note that the DJIA is not very “industrial” in terms of its composition. This is true enough, but the original DJIA launched in 1885 wasn’t very industrial either. Its main components were 11 railroad companies, the Delaware & Hudson Canal, the Pacific Mail Steamship, and Western Union. The high tide of manufacturing in the DJIA probably came around 100 years ago. Back in 1913 when corporate branding was incredibly dull and unimaginative, the DJIA featured Amalgamated Copper, American Car and Foundry, American Smelting & Refining, American Sugar, Central Leather, General Electric, National Lead, People’s Gas, U.S. Rubber, and U.S. Steel.