The Dow Jones Is a Useful, If Underused, Roadmap
President Donald Trump likes to tweet about the performance of stocks this year, most recently noting at the start of the month that the Dow Jones Industrial Average was on the cusp of reaching 22,000 and another record high. The implication is that the gains are a direct result of Trump’s performance and policies. But do U.S. presidents really drive equity market valuations? I suspect many investors would welcome such a paradigm if it actually worked.
In calling out the Dow, though, he is backing the right horse. The benchmark has racked up an almost 2,100-point gain this year, rising 10.6 percent. Main Street’s favorite measure of U.S. stock market performance has beaten Wall Street’s preferred metric -- the Standard & Poor’s 500 Index -- by more than 150 basis points in 2017, and the gulf is even wider over the last year at 590 points.
Of greater interest to market participants is how U.S. equities have gotten to this point, and what that journey means for the future. For that analysis, the Dow is a useful, if underused, roadmap.
The Dow, for all its price-weighted idiosyncrasies, has one commendable feature: simplicity. Thirty companies in a bucket with little turnover make for a straightforward measure of overall stock market performance. The chorus of sector performance shuffles to the back of the stage and individual stock returns gets the spotlight.
In terms of its performance in 2017, there is exactly one reason why the Dow sits at 22,000: Boeing Co. Thanks to a relatively high stock price, its current weighting comprises 7.3 percent of the index. Its 51 percent price return year-to-date translates into just over 700 points for the Dow, or 33 percent of its gain. In terms of contributions from the other 29 stocks in the Dow, it is a long way to second place. Apple Inc.’s 36 percent advance is worth 330 points. McDonald’s Corp. and UnitedHealth Group Inc. are essentially tied for third, with contributions of 268 and 230 points.
These three members plus Boeing represent 1,528 points of the Dow’s 2,096-point advance on the year, or 73 percent of the total. What if Boeing had performed this year more like its industrial peers and less like a juiced-up technology stock? The S&P Large Cap Industrial group is only up 9.1 percent in price terms for 2017, which means Boeing’s contribution to the Dow would be more like 120 points and the index itself would be trading 580 points lower.
At the losing end of the spectrum for Dow contributors sits Goldman Sachs Group Inc. and International Business Machines Corp., which together are responsible for just shy of 500 points in drawdowns for the Dow relative to their industry sectors. Goldman is down 6 percent on the year, even though financials as a group are up 6 percent. IBM has an even wider divergence from its tech-stock brethren, down 15 percent versus an 18 percent gain for the S&P Large Cap Technology stock index.
There are three takeaways from this analysis that not only touch on the Dow but the broader U.S. equity market as well.
The first is the Boeing story. Make no mistake, the move in this stock is unusual and important. For much of the last 10 years Boeing has largely tracked the S&P Industrials, but now it is diverging in dramatic fashion. While its dividend yield is 2.4 percent and therefore above market average payouts, its valuation at 22 times projected earnings is also higher than an already pricey market. Remember that Boeing has the largest weighting in the Dow, so any pullback here will show up in Main Street’s proxy for the health of capital markets. Given the historic link between equity price levels and consumer confidence, this bears watching.
The second is leadership, with the Dow’s leverage to a few key members mirroring the broader market. In the S&P 500, 45 percent of the index’s gains comes from 23 percent of the stocks by market capitalization (technology) and an additional 22 percent comes from another 14 percent (health care). That means more than two-thirds of the gains came from just over a third of the stocks. The Dow’s performance concentration in Boeing, Apple, McDonald’s and UnitedHealth tells a similar story. This worries those of us who like to see broad market participation in a rally already long in the tooth.
Lastly, the analysis points to the challenges for markets and investors. Winning groups such as technology need further catalysts and top-performing individual names such as Boeing are not cheap. The story for the rest of 2017 will either move toward sector rotation to pull along laggard groups and stocks, or finally deliver the pullback that has failed to materialize thus far.
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