When Charles Dow published the first Dow Jones Industrial Average ($INDU) in 1896 the name was more than apt. From American Cotton Oil to U.S. Rubber, there was no doubt the 12 original members of the blue-chip index were indeed smokestack companies one and all. It truly was an industrial average.
More than a hundred years on, the nation has changed, and the Dow, naturally, has changed with it. An economy that was once heavy on heavy industry has become dependent on financial services, technology, big-box retailing and pharmaceuticals. The Dow hasn't really been an "industrial" average since at least 1999, when the keepers of the average replaced Union Carbide, Goodyear Tire & Rubber (GT) and Chevron (CVX) (which was reinstated three years ago) with Microsoft (MSFT), Intel (INTC) and Home Depot (HD).
Today, fewer than a third of the 30 Dow components could still be considered smokestack companies. And yet it's the Dow's industrial members that have been doing the heavy lifting throughout the economy's -- and stock market's -- recovery. On Friday, we learned that industrial production rose in December by the greatest amount in five months. Total industrial activity has gained 11% since hitting its recession low in June 2009.
So perhaps it should come as no surprise that without the hardcore industrial components of the blue-chip average, the market's gains, as measured by the Dow, would look much, much worse over the past couple of years. By the same token, a DJIA comprising just its industrials would have fared much, much better. See the chart below.
The Dow was last reconstituted in June 2009, when Citigroup (C) and General Motors (GM) became wards of the state and were replaced with Travelers (TRV) and Cisco (CSCO). Using that date as a starting point, we broke the Dow out into two separate price-weighted indexes (because the DJIA is weighted by price), to try to isolate the contribution of today's smokestack companies.
Lo and behold: An all-industrial DJIA would stand at nearly 13,000 by now -- or more than a thousand points greater than its current level.
The actual DJIA is up 34% since June 8, 2009 (as of Wednesday's close), but a Dow consisting of just nine industrial names -- 3M (MMM), Alcoa (AA), Boeing (BA), Caterpillar (CAT), Chevron (CVX), DuPont (DD), Exxon Mobil (XOM), General Electric (GE) and United Technologies (UTX) -- would have gained 48% over the same span.
At the same time, a 21-member Dow that excludes the industrial names would have posted a gain of just 28% -- and be sitting at 11,238, or more than 500 points below where it is today.
This experiment has a couple of obvious takeaways. First, diversification mitigates risk. Notice how much more volatile the industrials-only Dow is compared with the actual Dow or to our 21-member non-industrials Dow. Second, energy, commodities, chemicals and capital goods have been a good bet in the last couple years, helped in no small part by the global economy's hotter corners. Thanks, China.
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