Squawk Morning Briefing: Get Serious

It seems unwise to complain about traders to a bunch of traders, especially if we were to go so far as to say that there are some who endeavor to trade who are always whining about some conspiracy theory or another and won’t be happy without someone to blame for manipulated markets. We are not so naive as to believe that markets are truly free. They can be manipulated and often are. However, that is a far cry from the view that just about any company or organization participating is somehow subverting the proper course of trading.

Today’s rant in a reaction to much of the writing about the change in composition of the DJIA. There is a narrative circulating which contends that enough low-priced “losers” are being removed and replaced by high-priced “winners” that the DJIA is manipulated in such a way as to make folks think the market is going up it really should be going down. It is being repeated often enough that it might soon be taken as truth. Let’s take a more serious view.

Assume for a moment that the committee which chooses DJIA components was trying to pick winners. In that case they would want to do what every successful investor does: buy low and sell high. If we saw a friend finally getting out of AA at multi-year lows (near decade lows) to turn around and buy NKE at all-time highs then we might try to make them aware of some strategies which had better potential. If the DJIA was truly trying to get outsized gains in a competent fashion they would likely be going about it in a different way.

And that brings us to actually looking at the results. Take a look at the Wilshire 5000, one of the broadest measures of the U. S. markets and you’ll see that it, like the DJIA, is near all time highs and that the two actually track reasonably well. Looking at the two side-by-side it would be hard to conclude that the folks behind the DJIA were obscuring market weakness by focusing on only a few winners. Instead, they seem to be doing their job quite well, reflecting the performance of markets in just a small number of stocks which are easy to track.

As an index, the DJIA has advantages and disadvantages. The fact that it has a small number of stocks and is price-weighted makes it easy to watch and know the impact of a move in any one stock on the index. However, it also is problematic when there is a wide disparity in prices of the components. It is hard enough to represent the entire market with 30 stocks, but when one of those stocks (IBM) is more than 20 times the price of another (AA) then some stocks matter too much and some too little. This is likely the real reason for the changes to the DJIA.

Even though changes might be the right thing to do, they can lead to dislocations. We’ll need to see if the DJIA’s outperformance to the downside on Friday is an artifact of the index change or a sign that more selling is on the way. More on this in today’s videos.

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