The new economy has finally come to the most public face of the stock market, the
Dow Jones Industrial Average
. And to most market participants, the question of what effect next Monday's
reconstitution of the Dow will have on the market is as meaningless as the well-meaning but deceptive abstraction of "the market" itself.
The effect will be "slim to none," ventures Thomas McManus, equity portfolio strategist at
Banc of America Securities
. The Dow's "just a yardstick. If we shifted over to the metric system and traded in our yardsticks for meter sticks, it wouldn't change the height of the Empire State Building. Though if we ask how many sticks it takes to get to the top of the Empire State Building, it's going to be different."
Make no mistake, the Dow's facelift should have some localized effects. The extra volatility of
should make options on the index somewhat pricier. The low-to-nonexistent dividend yields in three of the Dow's four new components will put a serious fly in the
Dogs of the Dow ointment.
In the larger picture, however, stocks will probably continue to trade as stocks -- even the lucky entrants and less fortunate emigrants, according to McManus. "The Dow's price-to-earnings ratio will go up, its dividend yield will go down," he says. "But that doesn't mean the market has gotten more expensive, though people will want to say this. The stocks don't know which indices they're members of. I'm not any more likely to buy Office 2000 because Microsoft is in the Dow."
Maybe not. But investors in stocks that enter and exit indices like the
are indeed aware of the logic of rebalancing, whereby incoming and outgoing stocks tend to get bid up and down as they're accumulated and dumped accordingly by money managers trying to track those market measures.
In this case, forget about that. The eight stocks involved in the Dow's reconstitution will see hardly any of that effect, as very little institutional money tracks that index, relative to the S&P 500. By way of example, a total of $326 million is indexed to the five Dow funds tracked by
, compared with the
Vanguard 500 Index fund's bodacious $89 billion in assets.
"The S&P 500 is the benchmark for institutional performance," says McManus. "The popular media still use the Dow because it has this long history."
It's difficult to imagine today's move by
changing any of that, despite the company's best efforts to compete with
Standard and Poor's
. "I think it's probably too late for that," says Jeff Warantz, equity strategist at
Salomon Smith Barney
. "The Dow is always going to be the index for John Q. Public. But that doesn't mean the more sophisticated investors and the institutions are going to use it. Everybody isn't going to suddenly make a massive shift because Dow Jones finally got on the stick and added Microsoft."
Closing the Perception Gap
If nothing else, even if managers don't start indexing to the Dow, the index's reconstitution may help close the gap between "the market" known by the public and the one that strategists like to talk about. Strategists typically use the S&P 500 when they calculate price targets, and translate those numbers for the Dow as a way to communicate with the media and, thus, the investing public themselves.
"If you've been extrapolating the S&P 500 to the Dow, you've been making a mistake because of that index's greater exposure to economically sensitive stocks," confesses Paul Rabbitt, president of
. "Now it's a more legitimate shortcut to make."
"I agree with that," says Stanley Nabi, chief investment officer at
DLJ Investment Management
. "Several years ago, in reporting our results to clients, we eliminated the Dow as a basis for performance comparison in favor of the S&P 500. You can select both, but if they go in different directions, you're going to have a problem. You had the Dow last year 1,200 basis points below the performance of the S&P 500. Which one is right?"
"What you want is one bogey," he continues. "It's enough to have one bogey to fight against, instead of two or three of them."
And no one likes a triple bogey.
For more discussion of the new Dow, don't miss our
TV show this weekend on
Fox News Channel
. This week's guest is Charles Carlson, manager of the
Dow 30 Value fund. The show airs Saturdays at 10 a.m. and 6 p.m. ET, and Sundays at 10 a.m. ET.