How often do people find out that you work in the investment business and immediately say “what’s the market going to do?” Our most common response is “Fluctuate,” which usually gets an eye roll or even a giggle. What we really want to do, though, is engage in an educational conversation about what they mean by the “market.”
Let’s first assume that when they are referring to the “market,” they are referring to stock markets and not bond markets. Let’s also assume that most people are not referring to global stocks (e.g. MSCI ACWI), which would be our preference, but instead recognize that they have been incorrectly trained to think of the Dow Jones Industrial Average (DJIA) as the “market.”
Below is a short commentary that drives home the point as to why the DJIA is a less than perfect proxy for the US stock market. Most importantly, its reliance on a stock’s price to determine its weight in the benchmark can be problematic. In this example, the author points out that, prior to its recent drop, Boeing accounted for 11% of the index due to its $422 stock price, while Pfizer accounted for 1% based on its price of $40, despite the companies’ nearly identical market cap valuations.
While certainly not a comprehensive examination, we thought this might be a good refresher about benchmark construction, and something you can turn to for client education purposes as needed. As always, please let us know if you have any questions.
Article: Boeing's Lesson About the Dow
March 29, 2018