Dow Theory Only Slightly Oversimplified

One of the most notable figures in American economic and business news is the DJIA, or Dow Jones Industrial Average. Every newscast in the nation broadcasts this number, if only as a filler screen before a commercial break. Despite this, many Americans do not know what this simple number means.

The Dow is an average of just 30 stocks deemed to be important by the nice folks at Dow Jones, price weighted (stocks with a greater share price — adjusted for past splits — move the index more than those with a lower share price). These are 30 of the largest companies in the United States, 30 of the most influential companies, 30 of the biggest non-government employers. You have very likely heard of these companies or their subsidiaries, and you have almost certainly come in contact with a product or service from one of these companies in the last 24 hours.

As of this writing, here are the components (and their stock ticker symbols):

3M (MMM)
Alcoa (AA)
Altria (Phillip Morris, MO)
American Express (AXP)
AT&T (T)
Boeing (BA)
Caterpillar (CAT)
Citigroup (C)
Coca-Cola (KO)
Dupont (DD)
Eastman Kodak (EK)
Exxon Mobil (XOM)
General Electric (GE)
General Motors (GM)
Hewlett-Packard (HPQ)
Home Depot (HD)
Honeywell (HON)
Intel (INTC)
International Paper (IP)
JP Morgan Chase (JPM)
Johnson and Johnson (JNJ)
McDonalds (MCD)
Merck (MRK)
Microsoft (MSFT)
Procter and Gamble (PG)
SBC Communications (SBC)
United Technologies (UTX)
Wal-Mart (WMT)
Walt Disney (DIS)

Now then, lets look at what happens if the economy is good. I’ll add the ticker symbols of the companies you positively impact. For one thing, you have money in the bank or brokerage account (AXP, C, JPM). So you go and buy things (WMT). Maybe you get Happy Meals for all the kids (MCD, KO). You don’t worry about what you buy at the grocery (KO, MO). Prescription costs don’t bother you either (MRK, JNJ). Go ahead and get a new computer, just like they’re getting at work (MSFT, INTC, IBM, HPQ). Why not a new car (AA, MMM, HON, GM, XOM)? Build a new house with a state of the art kitchen (HD, UTX, GE, CAT)? Go on that Disneyworld vacation, but take plenty of pictures (DIS, EK, BA, UTX, HON, GE). Be sure to keep up with the family (SBC, T, IP). Speaking of work, not only do you have a job, but you’re pretty busy there (MMM, IP, and just about every other component, depending on your profession).

In short, when you have money, it gets funneled through your bank then you spend it. This benefits Dow component companies. They make more money. Their share prices go up, driving the DJIA up. But wait, there’s more. All that stuff the theoretical good-economy you bought had to get to you somehow. So real market geeks look for “confirmation in the Transports.” The nice folks at Dow Jones have two more indices, the Dow Jones Utilities Index and the Dow Jones Transportation Index (strictly speaking, all 3 can be put together to form the Dow Jones Composite Index). So then if the DJIA companies are doing well, they must be shipping products, and therefore the Transports must be doing well.