Episode 443: Don't Believe The Hype : Planet Money Last week Apple was officially added to the Dow Jones Industrial Average. But just because Apple's in the club now, doesn't mean the Dow is a great measure of the economy.
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Episode 443: Don't Believe The Hype

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Episode 443: Don't Believe The Hype

Episode 443: Don't Believe The Hype

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CAITLIN KENNEY, BYLINE: If you watch the evening news on TV, it's pretty common to see something like this...


UNIDENTIFIED WOMAN #1: The Dow Jones Industrial Average is in positive territory by about 42 points.

UNIDENTIFIED MAN #1: The Dow is up 55 points right now.

UNIDENTIFIED MAN #2: The Dow is struggling to figure out which way it wants to go. It is slightly higher right now by 47 points.

KENNEY: The daily movements of the Dow are reported breathlessly by lots of news organizations, even our own.


UNIDENTIFIED WOMAN #2: On Wall Street, the Dow Jones Industrial Average is down about 100 points at 18,106.

KENNEY: But not everyone thinks the Dow deserves as much attention as it gets. Ladies and gentlemen, the official Debbie downer of the Dow Jones Industrial Average party, our own Adam Davidson. Hey, Adam.

ADAM DAVIDSON, BYLINE: Hey, Caitlin. And I'm very glad to be able to do an extended version of beating up on the stupid, stupid Dow.

KENNEY: Ever since I started working here at PLANET MONEY, Adam, you have been telling me everything that is wrong with the Dow. And I promise you - I promise you, man - today we will go through all your gripes about the Dow one by one. But for now, can we just, like, maybe start the show, play some music and welcome people?

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 lots of very smart people, not just Adam Davidson, hate this number so very much. Note - a version of this podcast originally ran in 2013. Spoiler alert - the Dow - still pretty crappy.




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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 of 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 & 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 that the companies don't change frequently at all.

KENNEY: This is John Shoven. He's director of the Stanford Institute for Economic Policy Research. And when we first spoke to Shoven for the show in 2013, he pointed out that Apple, one of the biggest companies, was not included in the Dow. This changed last week. Actually, last Thursday Apple was officially added to the Dow Jones Industrial Average, and AT&T lost its spot. But just because Apple's in the club now doesn't suddenly mean that the Dow is great. It's still missing some really big players.


SHOVEN: 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 - 505,000, respectively, stocks in their indexes - 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 100 shares. I'll sell them for $1 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, or market cap. It's when you multiply the number of shares a company has times the price of those shares. So I have a hundred shares at $1 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.

KENNEY: And the fact that the Dow does its math this way, this is a big part of the reason that Apple, one of the biggest companies, was kept out of the Dow for so long. Stocks that are really expensive, like your stock, Adam, they have an outsize impact on the Dow. And before last June, Apple's stock price was really, really high - like, $700 per share. And that would've meant that if it was in the Dow, movements in its stock price would have this crazy impact on the Dow as a whole. And the Dow didn't want that. But in June, Apple split its stock, meaning for every share someone had, they suddenly had more. Apple increased the number of shares outstanding, and the price went down a lot. Its stock is now trading at about $125 a share, a lot closer to the rest of the stock prices in the Dow Jones Industrial Average.

Now, Adam, I know the fact that the Dow does its math this way drives you nuts. And of course, you are not the only one. John Shoven from Stanford feels the same way. In fact, he said doing the math this way is not just dumb, 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 'cause 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 of - honestly, it's kind of a mistake in the way it was calculated.

You might ask, well, why do they do it so that - in such a stupid way? Well, in 1892, there were no computers. They did the simplest thing possible, which was take the numbers and add them up. And so this way 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.

KENNEY: (Laughter).

SHOVEN: You ask them why do they do this - I've always done it that way. 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, that 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, I like that.

KENNEY: (Laughter). All right. And the Dow is aware of this criticism. 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 re-weight 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 (laughter). That's so ridiculous (laughter).

KENNEY: Yeah, 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 as 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 do 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. Though, I will say, it is not PLANET MONEY. You have 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 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 'cause 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 work week. 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.

KENNEY: That's John Prestbo. And we were surprised to find out he was such an eloquent critic of people obsessing about the Dow because when we first talked to him for this story, he was the editor and executive director of the Dow Jones Indices. It was his job to track it. But he told us then that he didn't pay attention to it every day. And he said when he looked back at Charles Dow, the man who founded the Dow Jones Industrial Average in 1896, as far as he could tell, Charles Dow didn't bother to comment on it more than once a month.

DAVIDSON: 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, he told me that the panic of 1907 felt an awful lot like the panic of 2007 and 2008. There was 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 has 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 gage of how corporations are doing, but after all, we're interested in how workers are doing as well. And it doesn't gage that, so it wouldn't be my number one gage 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 disproportionally - 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 that 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. 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.


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 PLANET MONEY at 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.


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.

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