Why Bill Gross Is Right About Dow 20,000

Bill Gross is right. The 2.6 percent level on 10-year Treasuries is much more important than Dow 20,000.

How many more times must we write “antiquated”, “anachronism” or “relic” in reminders that the oldest index in the world is price-weighted? As Bloomberg Intelligence’s Eric Balchunas puts it, the gauge was designed before aspirin was invented.

Here are three ways that show how the Dow’s price-weighting methodology makes a difference.

The Dow Jones Industrial Average has climbed about 13 percent, or 2,250 points, since the end of 2015. Its four best performers, all rising a similar amount, added about 1,000 points between them. But look at the distribution of those points. A 30 percent gain in $309 billion JPMorgan was only good enough for 136 points, while $101 billion rival Goldman Sachs contributed 415 points with a 33 percent increase. The best performer in the index, Caterpillar, rose 37 percent and contributed 172 points, despite having a market capitalization of $55 billion. Size doesn’t matter in the Dow.

Price versus market cap weightings in action

A price-weighted index is a function of the share prices of its members, a market-capitalization index is a function of their market value. Under these different methodologies, an index with the same members, even over a short enough time frame, will clearly show different results.

Want to get the Dow above 20,000?

Time for an experiment. Let’s take $153 billion Cisco, which has the lowest stock price in the Dow, and see what happens when it’s replaced. Here’s what the Dow would look like when a selection of worthy constituents — $18 billion Campbell Soup (founded in 1869), $37 billion Emerson Electric (1890) or even $10 billion Harley Davidson (1903) — are added. 20,000! Just don’t replace it with $76 billion Priceline, it will take all the fun out of Dow 30,000.