Dow Theory remains relevant

Some criticize the Dow Theory because it relies on two price-weighted indexes launched in 1896, when calculations were done on slide rules rather than computers. Share prices are arbitrary because they depend on stock splits, which are arbitrary. As a result, the Dow Jones Industrial Average can diverge from the S&P 500 and most other modern benchmarks, which weight stocks by market value.

All those criticisms are true. If you wish to measure changes in the total value of big stocks, there is no doubt the S&P 500 does a better job than the Dow Jones Industrial Average. But measuring changes in total market value is not the goal of every index, and certainly not the goal of the Dow Theory.

Indexes are tools. The simplicity, broad popularity, and long histories of the Dow Industrials and Dow Transports make them useful for our purposes. We consider other indexes, and we’re encouraged by this month’s fresh all-time highs in the S&P 500. But weighting stocks by market value brings its own distortions, especially when just seven megacap stocks represent 35% of the S&P 500.

As a check on the Dow Jones Industrial Average, which has become top-heavy because of some very high-priced stocks, we consider the S&P 500 Equal Weight Index, which assigns equal weights to each of the 500 stocks. As a check on the Dow Transports, we consider the S&P 1500 Transportation Group Index, which is weighted by market value.

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