How the Dow Distorts the History of Wall Street: Echoes

On Nov. 23, 1954, the Dow Jones Industrial Average, after 25 long years, finally surpassed the high it had hit on Sept. 3, 1929. It remains, by far, the longest period between new highs on the Dow in the 115-year history of the index. And the story behind that long recovery tells us a lot about how statistics can distort our view of the past.

The day after the Dow reached its high of 381.17 in 1929, the market suddenly tumbled in the afternoon, with an unheard-of 2 million shares changing hands in the last hour of trading. For the next six weeks, the index trended downward until, on Oct. 24, it collapsed on extraordinary trading volume. A group of bankers intervened with $20 million in buy orders and stabilized the market.

But five days later, on Oct. 29, there was no stopping the most famous crash in Wall Street history. The volume record set that day, 16 million shares, would not be surpassed until 1968.

What began as an ordinary stock-market crash and recession deepened relentlessly into the Great Depression. And the Dow tracked the economy into the abyss. It finally hit bottom on July 9, 1932, when it closed at 41.22 -- down more than 89 percent from its 1929 high and only a quarter-point above its very first close in 1896.

The Depression lingered for 10 years, until World War II brought it to a decisive end. But as the war caused gross domestic product to soar and unemployment to virtually disappear, the Dow still didn't rebound. It closed 1942 at only 119, barely above where it had been at the end of 1933.

Why did the Dow take so long to recover?

For one thing, wartime taxes siphoned profits away. And Americans, badly burned in 1929, were still afraid to put their money into Wall Street. They invested in war bonds and savings accounts instead. Only in the postwar years, when Merrill Lynch started bringing "Wall Street to Main Street" by pursuing smaller accounts and rigorously training registered representatives, did people again look to the Street as a place to put their money.

But the Dow Jones Industrial Average itself was part of the problem. Begun in 1896 and named for Charles Dow, the publisher of the Wall Street Journal, and Edward Jones, a statistician, it is today the oldest continuous measure of the U.S. stock market and thus inescapable as a window into Wall Street history.

It can be a cloudy window. In 1896, there were, of course, no computers. Instead, at the end of the trading day, someone would add up the closing prices of the 12 original stocks in the Dow and divide that number by 12 to reach the average. (In 1928, the Dow was expanded to 30 stocks.) As companies were added and dropped, a mathematical formula was used to keep the average consistent, although not always perfectly so, especially in the early years.

The Dow was at first purely an industrial average, with separate averages for railroads and utilities. But it soon evolved into an index that tried to represent the U.S. economy as a whole. Today, the Dow contains such distinctly non-industrial stocks as Home Depot Inc. and JPMorgan Chase & Co., as well as General Electric Co. and Kraft Foods Inc. To better match the economy, Dow Jones has from time to time removed some companies from the average and substituted others.

In 1939, International Business Machines Corp. was removed from the average and replaced by AT&T. That was a fateful move. Over the next 40 years, before IBM was restored to the Dow in 1979, AT&T, largely a regulated utility, saw its share price increase about threefold. IBM, on the other hand, greatly expanded during the war and then moved into the soaring computer industry. Its stock increased about 22,000 percent between 1939 and 1979, one of the great investment success stories in Wall Street history.

Had Dow Jones just left well enough alone and stuck with IBM, the whole history of the average -- and thus the perceived history of Wall Street in the postwar years -- would have been different. The Dow would have recovered to its 1929 peak years sooner than it did, and marked many other milestones, such as reaching 1,000 points, earlier as well.

It's a beautiful example of how statistical tools, valuable as they are, can both determine and distort our view of history.

(John Steele Gordon is the author of numerous books, including "Hamilton's Blessing: The Extraordinary Life and Times of Our National Debt." The opinions expressed are his own.)


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