Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
Millions of investors look to the Dow Jones Industrials (DJINDICES:^DJI) as their key barometer of the stock market. Yet as we've seen throughout the past week, the Dow doesn't always move in the same direction as other parts of the market. For instance, before the market opened this morning, it looked as though the Dow would take a much different path from the Nasdaq Composite because of Apple's disappointing earnings report -- even though the two benchmarks are now both moving upward.
Yet even if the idea of adding Apple to the Dow is a nonstarter, there are other glaring omissions in this index that make it less than a perfect measure of the U.S. stock market. Let's look at a couple of areas where the Dow should consider adding stocks to be more representative of the economy at large.
When General Motors (NYSE:GM) went bankrupt in 2009, it made sense for the Dow to evict the automaker from its ranks. But now that the auto industry is back and driving ahead at full speed, the absence of the two publicly traded members of Detroit's Big Three leaves out a key part of the U.S. economy. According to the Center for Automotive Research, the auto industry has historically contributed between 3% and 3.5% of total GDP, employing more than 1.7 million people directly. When you consider jobs that rely on the sector, about 4.5% of private-sector employment is linked to the auto industry, according to data from the Auto Alliance.
At their current market capitalizations, both General Motors and Ford (NYSE:F) would be at the low end of the Dow 30. Ford's extremely low share price would give it an inconsequential impact on the blue-chip index, carrying only two-thirds of a percent of the Dow's total weight. General Motors would fare somewhat better, with a weighting of roughly 1.5%, making it a more logical choice even though some investors would balk at giving a bankrupt company a second chance. If Ford executed a reverse split to make its share price higher, its bailout-free history and strong earnings growth in its fourth-quarter report today would make it a more desirable choice for many investors.
There's nothing particularly exciting about commodity businesses, but they do make up a substantial portion of the U.S. economy. Energy is reasonably represented in the Dow, but providing other basic materials is critical to the proper functioning of the industrial sector. Yet after Alcoa's dismissal from the Dow and as DuPont moves away from its traditional chemicals business to focus more on agriculture, the subsector is underrepresented in the average.
The challenge, though, is that most U.S. companies aren't big enough to justify a place in the average. The steel sector, for instance, is incredibly fragmented, with former Dow component U.S. Steel (NYSE:X) carrying a market cap of less than $4 billion and therefore making it no better a choice for the index than Alcoa was. In mining and metals, adding Freeport-McMoRan Copper & Gold (NYSE:FCX) would be a bit more palatable, given the company's $33 billion market cap and its leadership role in the world copper market. Yet even there, Freeport's recent diversification into the energy industry makes it a less-than-perfect choice to represent nonenergy basic materials -- even if it might be the best among the choices available.
No matter which stocks you add to the Dow, the average will never be perfectly representative of the U.S. economy. But by addressing these two glaring omissions, the Dow could answer concerns that it no longer serves its function as the leading benchmark of the stock market.