We're less than two months into 2022, and several top stocks have already gotten absolutely crushed. Microsoft is down about 17% year-to-date (YTD). Adobe and Salesforce are down around 24% and 25%, respectively. Meta Platforms and Block are down over 40%. And former Wall Street darling Shopify is down 55% YTD and around 63% from its 52-week high.
Such sharp moves to the downside are a reminder of the adage that investing is like taking the stairs up and the elevator down. Put another way, the stock market goes up more than it goes down, but it goes down faster than it goes up.
Amid all the turmoil, it can seem perplexing that the Dow Jones Industrial Average (DJIA) is only down about 8.8% for the year. Let's take a deep dive into the Dow to see why the index has been relatively resilient amid this market sell-off.
Understanding a price-weighted index
The DJIA consists of 30 components that are price-weighted, meaning that companies with higher nominal stock prices are going to carry more weight in the DJIA than lower-priced names. For example, UnitedHealth Group has a stock price of around $460 per share, compared to Intel's $45 per share -- meaning UnitedHealth will carry more than 10 times the weight of Intel in the DJIA.
Compare these lopsided weightings to the S&P 500, which is market-cap-weighted. In the S&P 500, UnitedHealth's $432 billion market cap would make it less than 2.5 times the size of Intel's $182 billion market cap.
Composition of the Dow Jones Industrial Average
Unlike the S&P 500, over a fourth of which is tech stocks, and the Nasdaq Composite, which is about 44% tech stocks, just 17% of the DJIA is in tech stocks.
What's more, the tech stocks in the DJIA are Apple, Cisco, International Business Machines, Intel, Microsoft, and Salesforce -- which tend to be more stable than smaller, more volatile hyper-growth tech stocks. All six companies are also profitable and less vulnerable to inflation and rising interest rates than smaller companies that are more reliant on capital markets.
Notice that around 40% of the Dow is in healthcare and financial stocks. These names, like UnitedHealth, JPMorgan Chase, and American Express, to name a few, aren't typically the kind of companies that retail investors go after for outsized returns. Rather, they are stable, established, and somewhat boring companies known for growing at or above the rate of U.S. gross domestic product (GDP). They also happen to be resistant to inflation (healthcare companies can pass along higher costs to customers) and rising interest rates (which banks tend to like).
Now that we have a better understanding of the DJIA, we can figure out why it's only down 8.8% for the year. For starters, six of the 30 DJIA components were up for the year (as of Feb. 23). In fact, if we calculate the weight of each of those names in the DJIA, we'll conclude that they collectively contribute a 1.44 percentage point gain to the DJIA -- meaning that the other 22 components must be averaging a 10.26% loss for the index to be down 8.8% on the year.
Let's take it a step further by finding the average performance of each sector of the DJIA. We can do that by taking the price of each stock in a sector, adding them up, getting the weight of each stock in that sector, multiplying its performance by its weight, and then adding up those weighted performances to get the YTD sector performance. Don't worry, I crunched the numbers to save you the trouble.
|DJIA Sector||Year-to-date Performance|
Here we see that the energy and materials sectors are up for the year, but they barely carry any weight in the index. The financial sector is about flat, and that matters a lot because it's the heaviest-weighted index in the DJIA. The only sectors that are underperforming the DJIA's -8.8% YTD return are the industrial sector (barely), technology, and consumer discretionary. In sum, the poor-performing sectors don't make up enough of the DJIA to move the needle. And even if they did, their losses are mitigated by the comparatively good performance of other sectors of the economy.
How the DJIA affects your investments
It's unlikely you own a DJIA index fund, or even use it as a benchmark to compare against your portfolio. However, understanding the composition of the DJIA and why it's outperforming the S&P 500, Nasdaq Composite, and many individual stocks this year can be a useful exercise.
The biggest lesson is that we are all biased. If you're a growth investor, it's easy to get caught up in the steep sell-off and feel like the whole market is crashing. In reality, many sectors of the market are doing just fine.
The DJIA's performance also illustrates the advantages of operating a diversified portfolio. Energy, real estate, and financials were the three worst-performing sectors of 2020, but the three best-performing sectors of 2021. Similarly, value investing is back in style after underperforming growth for years. Portfolio allocation will depend on your investment horizon, risk tolerance, financial goals, and personal interest. But most folks stand to benefit from not being all-in on small-cap growth or a particular sector. Attempting to time the market by switching in and out of what's working or not working in the short-term is a great way to lose money.
And finally, the DJIA's performance, as well as the S&P 500 being down 11.3% in what can feel like a market crash (it's actually just a correction), shows us that quality businesses that are established in their industries tend to outperform less proven companies during a market downturn. Investing in large-cap stodgy companies is unlikely to produce market-crushing returns, but there's also a lot less downside risk. Understanding what you own and why you own it, as well as making sure your allocations are at healthy levels, are two steps you can take now to prepare for further market volatility.