When is a Low Not a Low?

I was watching Larry Kudlow’s show on TV last night.  He asked his panelists whether the Dow’s breakdown to new closing lows yesterday also occurred in the broader indices.  I was shocked that only one of the 4 panelists knew the answer.  This is something I’ve been following naturally since I benchmark to the Russell Indices.  I thought this might be of interest to our readers.  Here’s the 6 month Dow Jones Industrial Average chart:

Dow Jones Industrial Average

Dow Jones Industrial Average

For the Dow Jones Industrial Average, yesterday’s action established both new closing lows and new intraday lows, beating levels established on 11/20/08 and 11/21/08 respectively.

The Russell 3000, a broad based benchmark, shows a different picture:

Russell 3000 Index

Russell 3000 Index

As is evident, the Russell 3000 is still roughly 5% above its lows established in November (the intraday low was 420.31 on 11/21/08).

Which is the better measure?  Although the Dow Jones gets all the press (nice to own the major financial publications!), I’d argue that the Russell is a better measure of the market.  The majority of institutional investors use the Russell indices as benchmarks, so I have good company in my preference. 

Why the different picture?  The Dow is a very narrow measure, reflecting only 30 companies.  The choice of the companies included is fairly arbitrary, and the Dow Jones company has had a tendency in recent years of poor timing in changing the index composition; e.g. in November 1999, Intel and Microsoft were added 6 months before the peak of the technology bubble, Bank of America was added in early 2008, etc.  The prominence of financial companies in the index (AXP, BAC, C, JPM) as well as a quasi-financial (GE) and an auto (GM) have overweighted the index to some losing sectors. 

The Russell 3000 is a broader index incorporating mid-cap and small companies as well as large.  However, the superior recent performance relative to the Dow is not a matter of having smaller cap sector — the Russell 1000, a large cap index, also has held its low.  Besides avoiding some of the Dow’s unfortunate industry concentrations, the Russell’s capitalization weighting of individual companies is also beneficial — the truly disasatrous names have shrunk in market cap, reducing their weighting.  The Dow by contrast is price-weighted, so roughly speaking, a stock whose market cap has shrunk to mid-cap size (e.g., Citigroup), impacts the index as much as a move in a company 30 times larger (e.g., XOM).

The key point is that the Dow is not a particularly good measure of the market.  All the focus on “breaking the lows” may make good headlines, but offers little insight into the markets.  By the measures used by most institutions, the lows are holding.  Let’s hope that continues.

Disclosure:  our clients hold positions in some of the stocks mentioned in this article.

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One Response to “When is a Low Not a Low?”

  1. Is Relative Performance Pointing to New Leadership? « (in)efficient frontiers Says:

    […] (in)efficient frontiers Inefficient Frontiers: insight on our less-than-efficient markets and the risks of life on the investment frontier « When is a Low Not a Low? […]

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