By Mickey Welcher
The Dow Jones Industrial Average is closing in on the 20,000 level. We hear about it every day on TV, radio, print and from friends. This is a huge topic of conversation, but should it be such a big deal?
My answer is “not really.” Here’s why.
It’s Made Up of Only 30 Stocks
Yes, the Dow Jones Industrial Average consists of just 30 stocks from different sectors. They’re considered to be the leaders of their respected industries, but again, are only 30 stocks. Each one is price-weighted to compensate for splits, spinoffs or structural changes (you can email me for a more detailed explanation). What’s more, the top five weighted stocks in the Dow (Goldman Sachs, 3M, IBM, United Health & Boeing) account for almost one-third of the index’s performance. This makes it hard to completely trust it.
Out with The Bad, in with The Good
Over the years, Dow stocks get replaced due to many factors, but mostly because the companies are no longer considered the industry leaders. They fail to perform well and are swapped for a rival that is. The last change was March 19, 2015, when Apple replaced AT&T. Before that was Sept. 23, 2013, when Alcoa, Bank of America and Hewlett-Packard were replaced by Goldman Sachs (now the highest weighted stock in the average), Nike and Visa. Replacing stocks provide a boost to performance, helping to inflate the average investor confidence.
The Run May Be from Over-Exuberance
20,000 is a huge number for the market, and all investors are excited to see this happen. They’ll put even more money into the Dow as the milestone gets closer. It’s a self-fulfilling prophecy. This type of run-up is usually short-lived, though, as larger investment houses will start taking some profits soon afterward, believing, and often rightfully so, that stock prices are overvalued.
So the real question is when — not if — we do break 20,000, where we will go from there? While no one truly knows, earnings season is underway and always adds volatility to the market. We’ve also seen many brick and mortar retailers announce recently lower than expected sales from the holiday season. In addition, the upcoming political debates on new fiscal policies will most certainly impact the market.
On the plus side, though, we know that there’s a ton of investor cash still sitting on the sidelines that may be coming out over the next few months and could positively affect the market. Investors with so-called “dry powder” could opt in even if others start to bet against Dow’s ability to stay above 20,000.
No matter what happens, the watchword for investors is to be cautiously calm. Volatility will increase with large moves in both directions that will make the novice investor uneasy. Rest assured; we’ve been here before. It’s all going to be okay in the long term.
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