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A comment I already made a long time ago: DJIA is a crap index, technically speaking, for two reasons:

  • it is price-weighted, instead of capital-weighted (that is, it gives more weight to shares with a prices than to shares of a economically more significant companies)

  • the sectorial mix / inclusion criteria are purely discretionary, including in frequency.

By contrast, S&P 500 is a lot less volatile, and not only because there are more shares: it is just a "top floats" list with sectorial cappings, making it objective, automatic, and a statistically significant sampling of the value of large corporations in America.

Because of these crappy characteristics, the DJIA "over-crashed" following the Depression (if S&P had existed, it would not have been divided by 10, may be just by 3 or 4). That is because bubble stocks were overweighted before the crash, and tiny caps were not replaced soon enough by resistant companies. At the time, DJ publishing company was not sophisticated enough to game the index.

But in the Raygun era, DJ became clearly aware of the public fixation on DJIA, and the ease with which it could be tampered without questions. The outdated formula became a feature, not a bug: you can manipulate the public perception of the performance of the stock market, by cherry-picking the DJIA companies, and by arranging for the "right" companies to perform/not perform stock splits.

Go googling across the web, you will find several articles from around 2007 explaining you that at the peak of the last bubble, the index looked 30% higher than in the dotcom area, when actually 20 out of 30 member companies in it where actually 30% lower than in 2000. Had it been cap-weighted with automatic replacement between 2000-2007, the DJIA would have been may be 10-11k instead of 14k at the peak (that is, a lost decade).

Pierre

by Pierre on Thu Aug 20th, 2009 at 08:12:18 AM EST

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