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The Dow Jones Industrial Average Turns 125

The Dow turned 125 in May, but it’s hardly in a retiring mood. The oft-cited stock index originated during a time when smokestacks and slaughterhouses dominated the American economy, but today’s Dow very much reflects our digital age. Plus, everyone knows what it is and what it stands for, said Jamie Farmer, chief commercial officer with S&P Dow Jones Indices.

The Dow’s story “is really one of consistency and longevity,” said Farmer, whose company runs the Dow and other equity indexes, such as the S&P 500.

The Dow, Farmer continued, is “a trusted barometer and trusted brand of market performance. For 125 years, the Dow has been the leading stock market indicator, a role it’s served through economic expansion and contraction, through times of peace and conflict. Its composition has reflected the birth and death of companies and entire segments of American industry.”

Farmer joined Tim McCourt, CME Group’s global head of equity index & alternative investment products, for a recent virtual Q&A session to mark the Dow’s 125th birthday. CME’s equity index contracts include E-mini and Micro E-mini futures and options based on the Dow.

During the first five months of 2021, over 184,000 Dow E-mini futures contracts traded each day, on average. Micro E-mini Dow contracts traded an average of more than 159,000 contracts daily in Q1 2021, setting a quarterly record.

The Origins Of The Dow Jones Index

The first futures contracts predated the Dow, but not by that long. In May 1896, Charles Dow, a Wall Street journalist, began calculating a daily average of 12 major, U.S.-based industrial stocks as a companion to the Dow Jones Transportation Average, which he introduced in 1884, according to S&P Dow Jones Indices. The basic idea was that an average of stock prices could serve as a barometer to help monitor broader market trends.

The original 12 Dow stocks read like a greatest hits list from the heavy industry era, with companies specializing in products or services related to coal, lead, sugar and tobacco. Most of the original 12 are long gone. Only General Electric (NYSE: GE) is still around in some form (though GE was removed from the Dow in 2018).

Today, the Dow stocks still retain an industrial element – oil and gas producer Chevron (NYSE: CVX), aerospace manufacturer Boeing (NYSE: BA) and construction equipment maker Caterpillar (NYSE: CAT), for example. But the Dow also leans heavily toward consumer technology, consumer products and financial services, with companies such as Apple (NASDAQ: AAPL), Intel (NASDAQ: INTC), JPMorgan Chase (NYSE: JPM), Nike (NYSE: NKE), and Salesforce (NYSE: CRM).

With a combined market capitalization in excess of $8 trillion, the Dow can be viewed as a bellwether of the U.S. economy. But it’s also a “living thing,” Farmer said, with a wealth of historical data that can offer insight into market performance and the path of the economy.

“The Dow evolves,” Farmer said, noting that S&P Dow Jones Indices periodically reviews the Dow’s composition to make sure it accurately represents the “mega-cap” segment of U.S. equities. The interconnectedness of the global economy also plays a role in the Dow’s make-up, he said. “The Dow’s continued relevance is reflected by its evolving composition.”

Simplicity In Investing

The past two decades have generated a boom for investors and traders, in terms of ways they can invest beyond traditional stocks and bonds, including mutual funds, exchange-traded funds, futures contracts, and, now, cryptocurrencies. There’s also more information than ever for investors and traders to absorb. How can the Dow remain relevant?

Part of the enduring appeal and utility of the Dow is its simplicity, Farmer said.

Equity indices generally have four different use cases, Farmer said. The initial use case, for the Dow and other indexes, was as a market indicator. From there, indices can serve as the basis for investment research and portfolio development, as well as a benchmark to judge the performance of those portfolios.

More recently, a fourth use case came about: indices as the basis for investment products, such as futures contracts, and the Dow futures contract, as an index-based financial product, was one of the earliest of those innovations.

“That evolution… emerged as really one of the most important for investors,” Farmer said. “Index-based investing has really exploded in recent years, reflecting both academic and empirical evidence of the outperformance of passive vs. active management. And products such as Dow futures may allow for facilitated investment exposure in risk management.”

The partnership with CME Group, the introduction of E-mini Dow futures, and the expansion of that toolkit have been nothing but a net positive for investors of all stripes.

“Investors all over the world, many of whom have investment exposure to U.S. holdings, rely on key indicators like the Dow to manage risk and interpret investment performance,” Farmer said. “The Dow is visible in media and market data venues all over the world. When people ask about how the market did today, usually the response involves the Dow.”

Image by S. B. from Pixabay

© 2021 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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