The Dow Jones Just Did Something It's Never Done in 121 Years

Markets Motley Fool

Who says Spain gets to have all the fun with the running of the bulls? The U.S. stock market has enjoyed a rampant running of the bulls for nearly nine years now, with all of the major indexes nearly quadrupling, or more, from their Great Recession lows.

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This is a first for the Dow Jones Industrial Average

This year has been particularly special for optimists, with no major corrections to speak of and each of the major indexes hitting plenty of all-time record closing highs. Of late, the biggest catalyst has been the expectation that the GOP tax plan will become law. With Republicans having a fairly strong majority in the House, and full partisan support in the Senate, despite just a two-seat majority, the Republican bill designed to lower corporate tax rates is viewed as a big boon to businesses.

The current peak marginal tax rate for corporations of 35%, among the highest in the world, will be replaced with a peak marginal rate of 21%. The GOP believes this extra capital will allow businesses to hire more workers, boost the wages of existing workers, and expand. This should, in turn, give workers extra disposable income, which is important since around 70% of U.S. GDP is based on consumption. In other words, Wall Street and investors see this sweeping tax reform as being exceptionally business-friendly, which is why stocks have motored higher.

But there was much more to the Dow Jones Industrial Average's (DJINDICES: ^DJI) 140-point gain yesterday that just its closing value of 24,792, another all-time high for the 121-year-old index. The 140-point gain represented the 70th time in 2017 that the Dow had closed at a new record high, surpassing the 69 record closing highs logged in 1995. Over 121 years, investors have never seen the Dow push into unchartered territory more than it's done in 2017.

Don't get too excited, folks, because the Dow is a flawed index

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But before you uncork the champagne, keep in mind that the Dow Jones is itself an archaic index that probably should have been put out to pasture a long time ago. It's kept around because of its history and prestige, but it holds very little value to investors in terms of giving them a feel for market sentiment relative to the broad-based S&P 500 (SNPINDEX: ^GSPC).

The biggest flaw with the Dow is that it's a share-price-weighted index rather one that's weighted by market cap. In plain English, it means companies with a higher share price have far more bearing than those with small share prices. Market cap has absolutely no influence on the Dow. This means Boeing, Goldman Sachs, 3M, UnitedHealth Group, and Home Depot are responsible for 8,276.16 current Dow points. Comparatively, the Dow components with the lowest share prices -- General Electric, Pfizer, Cisco Systems, Coca-Cola, and Intel -- are only responsible for 1,277.66 Dow points.

And here's the best part, the combined market cap of these latter five companies is $127 billion higher than the combined market cap of the aforementioned five Dow components with highest share prices, despite the former group having six and a half times as much influence on the Dow. That makes absolutely no sense, and it's a big reason the Dow is a terrible indicator of market health.

Building on this point, the Dow also fails to include some major market players because it's restricted to just 30 components and is intricately tied to share price. This means the second-largest company by market cap, Alphabet, the parent company of Google and YouTube, and its nearly $1,100 share price, along with Amazon.com (NASDAQ: AMZN) and its $1,190 share price, would wreak havoc on the Dow, and thus aren't included. In fact, using the Dow's current divisor, Amazon would account for a full third of the Dow's point value if it were one of the 30 components. Despite revolutionizing the retail landscape, and becoming a burgeoning cloud-computing player, Amazon's share price, short of a stock split, excludes it from being a Dow component.

It also fails to include major sectors because of its 30-component restriction. If you want exposure to the utilities sector, you won't find it in the Dow.

By comparison, the S&P 500 notched its 62nd all-time record close for 2017 on Monday, Dec. 18, tying for the second-highest number of record closes in a single year. The all-time closing high record is 77, set back in 1995. Therefore, while it's been a truly incredible year for stocks, it's not quite the best on record, even if the flawed Dow Jones Industrial Average suggests it is.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has the following options: short January 2018 $170 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends 3M, Cisco Systems, Home Depot, Intel, and UnitedHealth Group. The Motley Fool has a disclosure policy.