Thursday, March 1, 2012

Dow Jones Industrial Average Peaks Again
Short 2 min summary - one of many great intro videos from Investopedia

WSJ News Hub discussion on the importance of the Dow reaching 13,000 points again:

As in the videos, this post from correspondents from the Economist, , argues that there is nothing magical about a nice round number like 13,000.  It also lets finance newbies master a few facts to impress an interviewer:

1. The Dow Jones Industrial Average (DJIA) only tracks the stock prices of 30 stocks (which change over time).

2. The DJIA uses a silly method to compute the average stock price (with no weighting for market value), just to be consistent with how it was first computed back in the 1890's by WSJ editor Charles Dow and his business associate Edward Jones. To keep the index steady over time in spite of stock splits, dividends, and changes in composition, the DJIA is not simply the average of 30 stock prices.

3. The limitations of the DJIA aren't really important. The DJIA closely follows the trends of better stock price indexes (like the S&P 500). However the DJIA is widely followed by those who don't know as much as you do now, and therefore has a big impact on market psychology.

A quick search of the BLS website reveals that the CPI (all urban consumers, all goods) was 208.936 in October 2007 and 226.665 in January 2012. Using these CPI values to adjust for inflation, the Dow would have had to reach 15,366.44 = 14164.53x(226.665/208.936) by the end of Jan 2012 to be equivalent to 14164.53 in Oct 2007. As nice and round as 13,000 sounds, the market still has a long way to go to reach its previous heights.

In case you are curious, the current 30 companies represented in the DJIA are listed below. Note that many of these companies, such as Disney and Microsoft, are no longer heavy industrial companies.

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