Too Many Lousy Financial Stocks Have Kept the Dow Down This Year -- Here's How to Fix That

The Dow is too dependent on the financial sector, and nearly all of those stocks have underperformed. Why not make the index look more like the real American economy?

Apr 16, 2014 at 12:43PM

For the three and a half months of 2014 that ended on Tax Day, the Dow Jones Industrial Average (DJINDICES:^DJI) lost about 1.4%. Over the long run, this is pretty middling -- if the index performs similarly for the rest of the year, it would be weaker than 77 other years of the Dow's history stretching all the way back to 1896. On the other hand, it would be a better performance than 40 other years.

This year, as has often been the case when investors gravitate toward the stocks of smaller and newer companies, the Dow has underperformed its broader peer, the S&P 500 (SNPINDEX: ^GSPC), which is trading essentially flat past Tax Day. There are a few possible reasons for this situation, but one merits particular attention -- the Dow's overreliance on financial stocks has hurt it this year, as all but one sector component has underperformed the index as a whole:

^DJI Chart

^DJI data by YCharts.

Because these six components alone contribute over a quarter of the Dow's total value, they've been responsible for the lion's share of its decline. Goldman Sachs (NYSE:GS), the Dow's worst performer to date this year, is such a large part of the Dow that it effectively cancels out the gains of the index's two best-performing stocks, Caterpillar (NYSE: CAT) and Merck (NYSE: MRK), which have each gained about 13% in 2014:

GS Total Return Price Chart

GS Total Return Price data by YCharts.

Since the Dow is price-weighted, Goldman's current share price of $156 more or less balances out Caterpillar's $103 shares and Merck's $56 shares. The same problem crops up with the Dow's other best performers, which are negated by lousy financial stocks with large share prices. IBM (NYSE:IBM) has gained nearly 6% this year, and in any other year it would have been a major force for gains, but since Visa (NYSE:V) supplanted it as the Dow's largest-weighted component, it's been completely negated by the credit card issuer's doldrums:

IBM Total Return Price Chart

IBM Total Return Price data by YCharts.

I've pointed out before that the Dow depends too heavily on financial-sector stocks, and this could probably be remedied without too much difficulty. My suggestion, which would finally give the completely unrepresented real-estate sector some visibility on America's most-watched index, would be to replace Goldman Sachs -- a company that most Americans would argue should not represent the U.S. economy anyway -- with Simon Property Group (NYSE:SPG), the country's largest publicly traded real estate investment trust. With that one change in place, the Dow would probably become a much stronger index, both in terms of economic representation and performance:

^DJI Chart

^DJI data by YCharts.

Since Simon's shares are now more valuable than Goldman's, the change would provide stronger representation for real estate than it would have when I first made this suggestion, and it might be enough to swing the Dow to a gain -- and a new record -- for 2014.

Do you think this change makes sense? Would the Dow be a better index with a REIT on its roster? Let me know what you think by leaving a comment below.

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Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more insight into markets, history, and technology.

The Motley Fool recommends American Express, Goldman Sachs, UnitedHealth Group, and Visa. The Motley Fool owns shares of International Business Machines, JPMorgan Chase, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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