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Performance of Dow Jones Industrial
Average: micro and macro-level analysis
Luis PalaciosRabih MoussawiDenys GlushkovBob Zarazowski
Motivation
Dow tends to hover around 1,000 and 10,000 thresholds for some
time. Is it psychological anchoring of investors or there are
fundamental explanations behind it?
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10,000
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DJIA
Overlaying 1966-1982 DJIA performance with 1997-2010
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1997_2010
1962-1982
Micro approach: DJ constituents• Pretty impressive coverage in terms of fraction of the entire market cap, ~20%
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Dow Jones Coverage as % of Total Equity Market Capitalization
DJ Coverage % of Market Cap
Performance of DOW vs total stock market
• How good was DJ composition reflective of the overall US economy over time? DJIA returned less than the overall market, especially during 1977-1982 period.
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$100 Buy and Hold DJIA vs Total Equity Marketbased on real returns incl. dividends (adjusted for inflation)
DJIA with Dividends Total Market Returns incl Dividends
S&P appears to be more reflective of the overall market performance
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Performance of Dow Jones versus Total Market Index vs SP500, levels (Excluding Dividends reinvestment and inflation adjustment)
1966-1982
Dow Jones Index Level Total Market Index S&P 500
Much more aligned later due to better representation of key industries of the economy
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Performance of Dow Jones versus Total Market Index (Excluding Dividends reinvestment)
1982-1999
Dow Jones Index Level Total Market Index S&P 500
Dow as better gauge of overall market performance in the most recent period
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Performance of Dow Jones versus Total Market Index (Excluding Dividends reinvestment)
1999-2009
Dow Jones Index Level Total Market Index S&P 500
Fama and French 12 Industry Classification
Industry Name Description
1 NoDur Consumer NonDurables -- Food, Tobacco, Textiles, Apparel, Leather, Toys
2 Durbl Consumer Durables -- Cars, TV's, Furniture, Household Appliances
3 Manuf Manufacturing -- Machinery, Trucks, Planes, Off Furn, Paper, Com Printing
4 Enrgy Oil, Gas, and Coal Extraction and Products
5 Chems Chemicals and Allied Products
6 BusEq Business Equipment -- Computers, Software, and Electronic Equipment
7 Telcm Telephone and Television Transmission
8 Utils Utilities
9 Shops Wholesale, Retail, and Some Services (Laundries, Repair Shops)
10 Hlth Healthcare, Medical Equipment, and Drugs
11 Money Finance
12 Other Other -- Mines, Constr, BldMt, Trans, Hotels, Bus Serv, Entertainment
-25.00%
-20.00%
-15.00%
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-5.00%
0.00%
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15.00%1
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DJIA Constituents Performance - By Industry1966-1982
NoDur Durbl Manuf Enrgy Chems BusEq
Telcm Utils Shops Hlth Money Other
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Overall Market Performance - By Industry1966 - 1982
NoDur Durbl Manuf Enrgy Chems BusEq
Telcm Utils Shops Hlth Money Other
Correlation of DJIA Index with Cumulative Industry Returns, by Decade
Bu
sEq
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1960 70% 97% 95% 88% 77% 81% 66% 82% 84% 79% 90% 93%
1970 50% 62% 66% 19% 53% 55% 44% 55% 39% 74% 24% 27%
1980 87% 100% 99% 96% 99% 99% 98% 99% 99% 98% 96% 97%
1990 96% 99% 99% 98% 99% 96% 99% 97% 96% 98% 95% 96%
2000 41% 62% 68% 63% 85% 87% 81% 68% 89% 77% 44% 74%
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BusEq Chems Durbl Enrgy Hlth Manuf Money NoDur Other Shops Telcm Utils
Correlations and Performance of Dow Jones Returns with Monthly Industry Returns: 1966 - 1982
Average Annual Correlations Total Cumulative Returns
-100%
-50%
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BusEq Chems Durbl Enrgy Hlth Manuf Money NoDur Other Shops Telcm Utils
Correlations and Performance of Dow Jones Returns with Monthly Industry Returns: 1999 - 2009
Average Annual Correlations Total Cumulative Returns
Macro look: DOW and Fundamentals• How much Dow performance is correlated with the overall economic indicators
• We looked at
– CPI (consumer price index)
– PPI (producer price index)
– Default spread (difference between Moody’s Baa and Aaa-rated portfolios
– Term spread (measuring slope of the yield curve)
– Quarterly productivity of the business and manufacturing sectors of the economy
– Industrial Production index (from the Federal Reserve)
– Aggregate dividend yield of the market
– Purchasing Managers Index (PMI) and New Factory Orders from the Institute for Supply Management
– Seasonally-adjusted Initial and continuing claims
– Total nonfarm and private payrolls
Correlations with fundamentals 1966-1982, 1982-1999, 1999-2009
DJIA S&P500 DJIA S&P 500 DJIA S&P 500Period jan 1966-Nov 1982 Dec 1982-Mar 1999 Apr 1999-Dec 2009
Mean 853.37 95.46 3520.05 440.14 10523.15 1205.02
STD 95.28 16.66 2247.53 273.35 1429.20 197.21
Nobs 251.00 251.00 196.00 196.00 123.00 123.00
DJIA (level) 1.00 0.79 1.00 1.00 1.00 0.90
S&P 500 (level) 0.79 1.00 1.00 1.00 0.90 1.00
CPI (all items) 0.24 0.71 0.89 0.87 0.30 0.00
CPI (less energy) 0.25 0.71 0.89 0.87 0.23 -0.07
Default Spread 0.16 0.55 -0.70 -0.68 -0.38 -0.50
Term Spread 0.07 -0.01 -0.45 -0.45 -0.50 -0.66
Industrial Production 0.39 0.74 0.97 0.96 0.78 0.61
Business Sector Productivity 0.40 0.73 0.91 0.91 0.19 -0.14
Manufactruting Sector Productivity N/A N/A 0.97 0.96 0.27 -0.05
Producer Price Index 0.22 0.68 0.83 0.80 0.43 0.18
Value-weighted Dividend Yield 0.18 0.54 -0.85 -0.84 0.34 0.11
Purchasing Managers Index (PMI) from ISM 0.18 -0.16 -0.11 -0.12 0.28 0.30
New Factory Orders 0.19 -0.15 -0.13 -0.14 0.14 0.14
Initial Claims (seasonally adjusted) -0.07 0.31 -0.44 -0.43 -0.48 -0.61
Continuing Clams (seasonally adjusted) -0.03 0.28 -0.28 -0.27 -0.48 -0.68
Total nonfarm payrolls 0.35 0.74 0.89 0.88 0.53 0.33
Total Private Payrolls 0.34 0.75 0.90 0.88 0.59 0.44
RD/Assets 0.08 0.28 0.92 0.91 0.66 0.47
Can proxies for the innovation intensity of the US economy explain DOW performance?
• RD/Assets ratio and DOW performance seem to comove reasonably well: 93% correlation over the entire period– RD/Assets ratio flat during 1970-1982, just as Dow is flat around 1,000 mark
– Steady increase in R&D is accompanied by a steady increase in Dow
– Relatively flat Dow performance around 10,000 is associated with flat (even decreasing R&D during 1999-2009
0.00%
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DJIA Median RD/Assets
Industrial Production: leading or lagging?
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Industrial Production DJIA (real terms + div)
Composition of US economy has been changing during the period. However, the general pattern, from goods to services was not alter. No
change on change.
Number of Employees by Industry (Proportion of Total) 1962 1982 1998 2008
All Industries 100.0 100.0 100.0 100.0
Selected Groups
Agriculture 3.1% 1.7% 1.0% 0.9%
Construction 4.6% 4.2% 4.7% 5.2%
Manufacturing 24.7% 18.1% 13.3% 9.4%
whole sale trade 4.5% 4.8% 4.2% 4.2%
Retail Trade 9.6% 10.9% 11.2% 10.9%
Finance, Insurance, Real Estate 3.4% 4.3% 5.8% 5.7%
Professional and business services 4.3% 7.5% 11.5% 12.6%
Educational Services 1.1% 1.4% 1.7% 2.2%
Health Care and Social Assistance 3.2% 7.1% 9.5% 11.1%
Arts, entertainment, recreation, accommodation, and food services 4.9% 7.0% 8.5% 9.5%
Government 20.1% 19.5% 16.9% 17.4%
Source: BEA
Price/Earnings Ratios as Predictor of Future 20-year Returns? (Source: Shiller)
See 1970-1985
Historical P/E Ratios. Would Historical high ratios imply lower returns in the future?
Exploration on House Bubble 2000’s
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Real Home Price Index Real Building Cost Index
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Proportion of GDP into Construction and Real Estate activities 1998-2009
Construction Real Estate - Finance
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