Putting the Dow Into Perspective

Have you recovered yet from celebrating the Dow's record highs last week? Hope you didn't go too wild. Hangovers can be so nasty -- though it sure was fun watching folks on the New York Stock Exchange floor whoop it up as the Dow finally eclipsed its highs set in early 2000.

But in my customary role as party pooper, I'll let you in on a little secret: Even though the Dow has broken the high it set on Jan. 14, 2000, the market is nowhere near its all-time high. That's because the 30-stock Dow Jones industrial average isn't the same thing as the U.S. stock market. Not even close.

Although the Dow notched three straight records last week and ended yesterday close to 12,000, the real market indicators are still way below their highs. One of them, the Standard & Poor's 500-stock index -- which includes 470 more stocks than the Dow does -- ended the week 12 percent below its peak, reached on March 24, 2000. The Dow Jones Wilshire 5000, which includes all U.S. stocks and peaked the same day as the S&P, was down 8 percent.

The Dow's stocks represent less than one-third of the value of the S&P stocks and less than a quarter of the Wilshire's. So why's everyone so Dow-obsessed? I think it's because the Dow, created in 1896, was well entrenched in the public psyche by the time more useful market measures such as the S&P and the Wilshire emerged in 1957 and 1974, respectively. The Dow has kept its overwhelming mind share, its shortcomings notwithstanding.

The S&P is the benchmark professional investors use to measure their performance -- but no one seems emotionally attached to it. When the Dow hit five digits in 1999, people wore Dow 10,000 caps. Have you ever seen an S&P 1,500 cap? Or seen people rooting for the S&P to set a record? I haven't. I've written a zillion articles about the Dow's reaching some benchmark, but don't think I've ever written about the S&P's doing that. The S&P is important but unloved. The Dow's not all that important, but the public loves it. Go figure.

Even Roger Ibbotson, founder of Ibbotson Associates, which uses S&P statistics to provide data on the market's long-term performance, says he answers in terms of the Dow when someone asks him how the market's doing. "It's a brand name," he told me. "When you want tissues, you ask for Kleenex. When people ask about the market, they want to know about the Dow."

This defies logic, because the S&P is a far-better indicator of how investors are faring. The S&P, you see, is based on companies' stock-market values, and the Dow is based on their stock prices. The S&P values a dollar change in the price of GE's 10.4 billion shares more than 18 times as much as a dollar change in GM's 566 million shares. That's logical, because a dollar change in GE's price creates (or vaporizes) vastly more shareholder wealth than a buck change in GM's. By contrast, the Dow counts a dollar swing in GE or GM stock exactly the same: 8.004 points. That's because the Dow is calculated by dividing the combined share prices of its 30 stocks by a wonderfully precise number: Currently, it's 0.12493117. (I'd explain how this "Dow divisor" works, but it's really complicated; let's deal with it another day.) The Dow's just so random. Had each Dow stock finished two cents lower Tuesday, the Dow would not have set a record. A 100-point move sounds like a lot -- but it's less than 42 cents for each Dow stock. Finally, you can argue that the Dow hasn't really exceeded its all-time high: It posted a midday high of 11,908 on Jan. 14, 2000, and didn't top that last week.

But enough ragging on the Dow. Now, let's see what we can learn from watching it. For starters, the Dow shows that there's no sure thing when it comes to investing. During the generation-long bull market that started in 1982 and ended in 2000, millions of people were lulled into believing that owning stocks of big companies was a sure way to wealth. But it wasn't. If you owned the Dow since it peaked in 2000, you've gotten essentially no capital gains. But if you'd owned "value" issues or shares of mid-size or small-size companies, you did extremely well.

Things are going well these days for large-capitalization stocks -- the Dow's up 11 percent for the year. That's double its 80-year average of 5.5 percent, as calculated by Ibbotson Associates. But it's not a great year for another market measure, the Nasdaq, which is up only 5 percent and is 54 percent below its 2000 high. It has to more than double just to get back to where it was almost seven years ago.

Be my guest, celebrate the Dow. Just don't confuse it with the market. They're different things.

Sloan is Newsweek's Wall Street editor. His e-mail address issloan@panix.com.