Episode 443: Don't Believe The Hype

Mar 12, 2013
Originally published on March 13, 2013 9:20 am

Despite all the celebration, the Dow Jones industrial average has not hit record highs recently. If you adjust for inflation, the highs just aren't as high as they seem.

And even if it does hit a real, inflation-adjusted high in the next few weeks, it won't mean much. The Dow is a seriously flawed stock index, and it's certainly not a good way to measure what's going on in the overall economy.

On today's show, we rain on the Dow's parade and explain why a lot of very smart people say we should ignore the Dow.

For more on the Dow:

The Dow Isn't Really At A Record High (And It Wouldn't Matter If It Were)

Dow's 'Record Highs' Misleading Without Including Inflation

Music: Milo Greene's "What's The Matter." Find us: Twitter/ Facebook/ Spotify. Download the Planet Money iPhone App.

Copyright 2018 NPR. To see more, visit http://www.npr.org/.

CAITLIN KENNEY, HOST:

Last week, something amazing happened.

(SOUNDBITE OF MONTAGE)

UNIDENTIFIED MAN #1: Rejoice, America. The Dow has hit a historic high. Not everything...

UNIDENTIFIED MAN #2: The bulls continue their run on Wall Street yesterday. And the Dow opens this morning at a record high. The stock...

UNIDENTIFIED WOMAN #1: A day for the history books. The stock market on a rocket ride, blasting through a ceiling and closing at an all-time high.

UNIDENTIFIED WOMAN #2: Time to go out and buy yourself something shiny, folks. The economy is back. I know. It's only Tuesday. But so far this week, the good times keep on rolling.

(SOUNDBITE OF ARCHIVED RECORDING)

UNIDENTIFIED WOMAN #3: The Dow Jones Industrial Average finishing again at an all-time high. Seventh straight day of gains, the Dow tonight up 50 points at 14,447. Write it down. That is an all-time high, uncharted territory for the industrial average.

KENNEY: Everybody, it seems like, has been celebrating this record climb of the Dow - well, everybody except for this one grumpy guy.

ADAM DAVIDSON, HOST:

It did not reach a record this week.

KENNEY: That's right. That's our own Adam Davidson serving as the official Debbie Downer of the Dow Jones Industrial Average party. Adam talked to Melissa Block on All Things Considered last week, and he explained his main gripe with all the celebration.

MELISSA BLOCK, BYLINE: Wait a minute, Adam. That's - front pages, news programs all over the country, including this one, talked about a record high being set.

DAVIDSON: Here's the thing. For reasons I cannot understand, nobody adjusts for inflation when they're talking about the Dow. I don't understand why.

KENNEY: Pesky old inflation. Luckily, we have Grumpy Gus here himself to explain the problem.

Hey, Adam.

DAVIDSON: Hey, Caitlin. And I'm very glad to be able to do an extended version of beating up on the stupid, stupid Dow. So, first of all, to get at this whole issue of - did the Dow reach a record? - absolutely not. It's still 11 percent below the record it reached back in 2000. If you adjust for inflation, which you have to do, which we do with every other economic statistic, the Dow, in fact, would need to hit in today's dollars 15,731 to break the 2007 record. It would have to go even higher than that to break the 2000 record.

Yesterday, it closed at 14,447. That is not a record. And I have to assume most of the people who say it is on the TV, they know it's not a record. And that - by the way, this inflation issue, that is just one part of why - you know this, Caitlin - why I hate the Dow Jones. And I hate that we report on it all the time.

KENNEY: Yes, I know. You've been telling me since I started with PLANET MONEY a while ago that the Dow basically sucks in your opinion. But don't worry. Today, we're going to go through all your gripes point by point. But for now, can we just play some music and start the show, maybe?

DAVIDSON: Absolutely. Hello. And welcome to PLANET MONEY. I'm Adam Davidson.

KENNEY: And I'm Caitlin Kenney. Today on the show, we rain on the Dow's parade and explain why a lot of very smart people - not just Adam Davidson - hate this number so very much.

(SOUNDBITE OF SONG, "WHAT'S THE MATTER")

MILO GREENE: (Singing) What's the matter? What's the matter with you lately?

DAVIDSON: So, Caitlin, let's just start with a quick introduction. What is this thing called the Dow Jones Industrial Average? So there's that big, complicated stock market, thousands of American companies or if you want to get really global, you know, tens of thousands of companies all over the world. And people want to know, well, how did that stock market do? How are investors looking at all those thousands of companies?

So the approach Dow Jones has is they just pick 30 large American companies. They take the share price of each of those, they add them up, and they divide them by a number. It's kind of an arbitrary number that they made up called the Dow divisor. And that is the Dow Jones Industrial Average.

KENNEY: And which companies are in that average, that's one of the first problems people have when they talk about what's wrong with the Dow because the choice of the companies kind of seems arbitrary. Like, they're all big, but they're not the biggest companies in America. And a lot of them like General Electric and Procter and Gamble, they kind of just seem like they're on there because they've been around forever.

JOHN SHOVEN: Stodgy - it's a stodgy index. The companies don't change frequently at all.

KENNEY: This is John Shoven. He's the director of the Stanford Institute for Economic Policy Research, and he's been teaching economics at Stanford for 40 years.

SHOVEN: You might notice that the Apple computer, one of the biggest, it's not on there. Google, one of the newer companies, it's not on there. Facebook's not on there. A lot of companies that get a lot of attention are not on there. It's only got 30 companies. And, by and large, these are old companies. So I say the Dow is really the worst of the indices.

DAVIDSON: Now, if I want to know how the American stock market is doing, I use the S&P 500 or the Wilshire 5000. I think that's what most people who care about this stuff use. They have - maybe not surprisingly - 500 and 5,000, respectively, stocks in their indices, a lot more than just 30 arbitrarily chosen ones. And they give you a much better sense of how the stock market overall is doing.

KENNEY: Yeah. It's not just the number of companies that's different between the Dow and these other indexes. Also, the way the Dow does its math is different. The way they calculate the industrial average is different than the way the other indexes do it.

DAVIDSON: Caitlin, why are you being so polite? It's not different. The way the Dow does it is idiotic. It is ridiculous. Nobody, nobody, nobody thinks it's a good way to do it. The way the S&P 500 and the Wilshire 5000 does it makes a lot of sense, and everyone agrees with it.

KENNEY: OK. OK. Well, let's just - let's play it out, all right? So let's explain to people how they do it and then we can get there. All right. So let's just say I have a company, Caitlin Inc. I'll call it. Very creative, I know. And I'm going to say there's a hundred shares. I'll sell them for a dollar each.

DAVIDSON: OK. And I'll be Adam Incorporated. And Adam Incorporated chooses like all corporations get to choose. Each corporation gets to choose how many stocks, how many shares it's going to divide itself into to sell to the market. So I've decided I'm only going to have two shares. I'm going to sell them each for $50.

KENNEY: Now, even though Adam and I are selling our shares for very different prices, I mean, we're roughly the same size. This is what we call market capitalization. Our market cap is when you multiply the number of shares a company has times the price of those shares. So I have a hundred shares at a dollar each. I have a market cap of a hundred.

DAVIDSON: And I only have two shares, but they're $50 each. So I also have a market cap of a hundred dollars.

KENNEY: OK. So we're the same size. Now, let's say both our companies go up 10 percent.

DAVIDSON: Yeah. We have a really good month. They both go up 10 percent. Now, your stock, since it's divided into a hundred small stocks, 10 percent would add a dime to each of those dollar shares. But mine, because I only have two shares each worth $50, a 10 percent increase means each of those are now worth $55. I've had a $5 increase in my share price, even though both our companies are now still worth the same. They're both worth $110.

KENNEY: Yeah. We're both the same size. We've both gone up by 10 percent. But the Dow, what the Dow really cares about is it cares about your $5 as opposed to my dime. Your $5 totally overpowers my dime because the Dow focuses on the share price.

DAVIDSON: In fact, if you had a good day, you went up 10 percent and I had a bad day, I went down 10 percent, the net result would be the same. The market was neutral. But the Dow would value it as a $4.90 loss that day. Just because I happened to have fewer shares than you, my stock price is way more influential. And, by the way, this happens all the time. This is not some theoretical idea. Take IBM and AT&T.

KENNEY: Right. Both companies, they're worth about $200 billion. They have a market cap of about $200 billion. AT&T's shares are only about $36, but it has a lot of them, like, over 5 billion shares.

DAVIDSON: Whereas IBM has fewer shares out there, only 1.1 billion. So its shares are worth much more. They're worth $210 dollars. So to the Dow, IBM is way more important. IBM goes up 10 percent, that's $21 added to the Dow. AT&T would have to go up almost 80 percent to add $21 to the Dow because IBM just happens to have fewer shares outstanding than AT&T does.

KENNEY: And, Adam, you are not the only one who this bothers. It also bothers John Shoven.

SHOVEN: See, it does not weight the companies by their importance to the economy. It weights them in a nearly arbitrary manner.

KENNEY: And he says doing things this way, doing the math like this, it could actually be dangerous.

SHOVEN: For instance, let's say that IBM did fantastic and the other - but most stocks did poorly. The Dow would get confused because it overweights IBM. And it might say the market's doing OK, when actually, most stocks are doing poorly and it just happens the one that they overweight is doing well. So it's just kind - it's - honestly, it's kind of a mistake in the way it was calculated.

And you might ask, well, why do they do it so - in such a stupid way? Well, in 1892, there were no computers. They did the simplest thing possible, which is take the numbers and add them up. And so this was a very, very simple thing to do rapidly, even before computers. And they've never changed.

KENNEY: So you're telling me the Dow is calculated this way simply because back in the day when they started, the math was a lot easier?

SHOVEN: I think that's right.

KENNEY: (Laughter) That seems crazy. Like, we have, you know...

SHOVEN: They do it like they do because they've always done it that way. I mean, we all know people like that. You ask them, why do they do this? I've always done it that way.

KENNEY: It sort of like...

SHOVEN: That's how the Dow is.

KENNEY: It makes me think the Dow's sort of like a luddite, right? Like, they don't want to respond to, like, new changes and new technology. I mean, we have amazing calculators and computer algorithms now that can complicate these really precise mathematical formulas. But they're like, nope, we're sticking with this way. We'll just do - add them up...

SHOVEN: I think you're - I don't disagree with anything you just said. I think that's right. Following the Dow is an activity for market amateurs. Nobody who really is a market professional would pay much attention to the Dow.

DAVIDSON: Now, I want to say, Caitlin, there's a reason why the Dow is so stodgy. It's actually a simple business reason. The Dow Jones Industrial Average, they like the fact, obviously, that the Dow is mentioned all the time. They make money off the fact that they have this benchmark index, and they want to keep that going.

But the Dow Jones Industrial Average has one advantage, only one over all the other ones. It's not more accurate, as we've discussed. It doesn't have a more clever algorithm. All it's got going for us is it's really, really old, that we all know it. And so they never would want to change it to make it more modern because that would destroy the one market advantage it has - it's really, really old.

KENNEY: It's kind of like the Colonial Williamsburg of Wall Street. Could you say that?

DAVIDSON: Yeah...

KENNEY: (Laughter).

DAVIDSON: ...I like that (laughter).

DAVIDSON: All right. But, you know, the Dow, they know that people say this about them, that people criticize the way they do their math. And on their website, they respond to it. They've got this document - Five Questions About The Dow That You Always Wanted To Ask. Number three addresses this very issue. It's a couple of paragraphs long, but the last two lines basically say it all. It says, quote, "with little to gain except maybe a reduction of criticism, we have no reason to reweight the Dow to market capitalization. And there would be a lot to lose, all the history that is in price-weighted terms."

DAVIDSON: I love that. They're basically fessing up. Like, the only thing we'd gain is all you people who know we're full of it would stop saying we're full of it. That's so ridiculous.

KENNEY: Yeah.

DAVIDSON: (Laughter).

KENNEY: And it's funny because, you know, when you ask people today, like, why the Dow gets so much attention, why we're so much more focused on it than, you know, the S&P 500 or other indices, they say it's history, just plain and simple. Here's John Shoven again.

SHOVEN: The only thing going for the Dow is it's 120 years old, so it has a very long history. People have followed it for years, and so there's interest in where it is now compared to where it was in 1929 or whenever. It's been here for all of our lifetimes and all of our parents' lifetimes and maybe even our grandparents' lifetimes.

KENNEY: Almost every other major stock index out there doesn't do the math this way. They don't focus on just the price of the stock as much as the Dow does. To try to figure out if a move in a stock price matters or not, they look at the whole size of the company, of the market capitalization, the number of shares out there times the price of those shares.

So a lot of people say the one thing the Dow is really supposed to do, to tell us what's going on in the stock market, it sucks at that. You know, Shoven says right now, yeah, things look good. And things are doing pretty well in the stock market. But overall, the Dow has a lot of flaws. It only has 30 stocks. They don't represent all the major companies in America. And they do their math in this crazy way.

DAVIDSON: But you know who gives the Dow power? It is not Dow Jones. You know, they provide the index, yes. But the people who give this index way more power than it deserves is us. It is the media. But I will say it is not PLANET MONEY. You've never heard us get all excited about the Dow Jones Industrial Average.

But I will say NPR and I've talked to senior leadership here and I've made my case, so far I haven't won, but NPR reports the Dow Jones Industrial Average every hour during trading hours. And we lead news with it when it allegedly breaks a record, so do the newspapers. It's not just cable news freaking out about it. It's responsible, sober media outlets that give it all of this coverage.

And this is so puzzling to me because I don't think you can talk to any market professional or any academic economist who would say, yes, I think the average American media consumer really should know what the Dow Jones is doing every hour of the day and every day of the workweek. In fact, I talked to one guy who was particularly critical of the obsessive way that the Dow covers the media. I asked him how often he checks it.

JOHN PRESTBO: Not every day. And I'm one of the people responsible for it.

DAVIDSON: That's John Prestbo. And I was surprised to find out that he was a particularly eloquent critic of people obsessing about the Dow because he is the editor and executive director of the Dow Jones Indices.

KENNEY: Right. This is his job to track it.

DAVIDSON: Exactly. And he says he doesn't pay attention to it every day. He said that he looked at Charles Dow, the man who founded the Dow Jones Industrial Average back in 1996. And Prestbo says, as far as he can tell, Charles Dow didn't bother to comment on it more than maybe once a month. So what happened? How did we develop this 24-hour fixation on the Dow? Well, Prestbo says it started like virtually all economic changes, with a panic.

PRESTBO: The panic of 1907.

DAVIDSON: When I talked to Prestbo last year, he told me that the panic of 1907 felt an awful lot like the panic of 2007 and 2008. There's this sudden, severe recession. Banks were collapsing. And nobody can make sense of the economy. Everybody is desperate for some handy metric to tell us clearly, in an instant - are we worse off today? Are we better off? Are we worse off this hour than we were an hour ago?

PRESTBO: So they looked around, and they found the Dow Jones Industrial Average. It took on a life of its own, shall we say?

DAVIDSON: Newspapers started referring to it sort of as a easy way of talking about how the overall economy is doing. And then it really took off during the Great Depression because obviously in the Great Depression, people really wanted to know, is this thing going to continue forever? Is this thing about to end?

General statistics, the kind of statistics we use now like the unemployment rate, et cetera, were still very immature. They were not very reliable. So the media had this handy thing, the Dow. It might satisfy that same need - how's this economy doing?

The thing is, what was true in 1907, what was true in 1937, what was true in 2007 and what is true today is not only is the Dow Jones Industrial Average a lousy way to know how the stock market is doing, even the best measure - the S&P 500, the Wilshire 5000, whatever - the best measure of the stock market is not necessarily going to help you understand how the overall economy is doing.

KENNEY: Yeah. I mean, it doesn't tell us about, you know, the things we care about, about GDP, the growth of the overall economy, about housing, about jobs. And John Shoven of Stanford says it and the rest of the stock market doesn't always match up with what's going on in our real economy.

SHOVEN: The Dow and the stock market in general tends to do better than the economy, grow faster than the economy. I think it's correlated with the economy but far from perfectly. It's a reasonable gauge of how corporations are doing. But after all, we're interested in how workers are doing as well, and it doesn't gauge that. So it wouldn't be my number one gauge for the economy.

DAVIDSON: There's been plenty of times where the stock market and the Dow have done very well exactly when there's massive layoffs and lots of unemployment. There have been lots of times where the Dow Jones goes up and wealth increases among the people who own stocks, which is disproportionately the 1 percent or the top 10 percent. You know, the bottom 50 percent of the country by income has virtually no stocks at all.

And - so very often when you're celebrating the Dow Jones going up, what you're celebrating is something that might be problematic - layoffs, more income inequality. It might not necessarily be that way either. It's just the Dow is just such a lousy measure of everything. It doesn't really tell you anything about how the economy is doing for the average person.

KENNEY: Yeah. I'm sure there's been a lot of people who have been watching TV last week and this week. And, you know, they hear these excited newscasters. They hear, you know, this idea of like, look at the Dow. It's doing amazing. But they're sitting there thinking, well, I don't feel great. You know, maybe I don't have a job. Or I'm worried about losing my job. You know, I think the reality that people are feeling on the ground is really different than what we are hearing reported right now.

DAVIDSON: Absolutely. That's why we at PLANET MONEY, we look at a lot of indicators about how the economy's doing. We look of course at the unemployment rate. We look at overall GDP growth. We look at income and wealth, inequality. I'm pretty sure that never in a meeting or just standing around the hallway we have ever discussed the Dow other than to talk about how much we hate it.

(SOUNDBITE OF MUSIC)

DAVIDSON: As always, we're eager to hear what you think about today's show. You know, I would love to see a full-throated defense of the Dow, how it's just an awesome metric. Or join us in hating on it at planetmoney@npr.org.

KENNEY: And, as always, you can find us on Twitter, Facebook and Spotify. I'm Caitlin Kenney.

DAVIDSON: And I'm Adam Davidson. Thank you for listening.

(SOUNDBITE OF SONG, "WHAT'S THE MATTER")

MILO GREENE: (Singing) What's the matter? What's the matter with you lately? What's the matter? What's the matter with you lately? Dreamer, you will waste your time. Do you ever wonder why we go on and on and on? Love is gone and gone and gone. Transcript provided by NPR, Copyright NPR.