Don’t confuse Dow Jones records for overall economic prosperity

The Dow Jones Industrial Average (Dow) is not the same as the stock market and the stock market is not the same thing as the economy; however, because this benchmark and others are so widely followed and considered by many as proxies for the economy, it is useful to understand what drives the Dow and why.

The Dow is a handful of public companies; it is not all public companies and public companies are only a fraction of the overall U.S. economy. There are large parts of America that are still unemployed or under-employed, a raging stock market means nothing to them on a daily basis. In fact, it still means to many people in that situation that “I am being left behind.” I think that message came through loud and clear in the last election. 

{mosads}Furthermore, the Dow is driven by only a few stocks within its small universe. Therefore, all the attention given to the Dow hitting new record highs (or falling to new lows) could actually be reflecting the performance of a handful of companies. To understand this, we need to understand how this index is constructed. On their web site, Dow describes the index this way: “Today, the index is made up of 30 companies, and represents industries ranging from financial services and health care to technology and telecommunications.” 

The index is also price weighted; therefore, since there are only 30 constituents and those are price weighted, the overall performance of the Dow is driven by a few, high-priced stocks. In a simple example, this means that in practice, a company with a market capitalization of $10 billion and a share price of $50 would have twice the impact on the overall movement of the index then a company with a market capitalization of $20 billion with a stock price of $25 share.

That means that the biggest component of the Dow right now, Boeing, has over nine times the impact of the smallest-weighted component of the Dow at this time, General Electric. 

So which stocks are moving the Dow now?  Currently, the biggest components of the Dow are Boeing (NYSE:BA); Goldman Sachs (NYSE:GS); 3M (NYSE: MMM); United Health (NYSE:UNH); McDonald’s (NYSE: MCD) and Apple (Nasdaq:AAPL). The current rise is being fueled by Boeing and McDonald’s. As Alex Schiffer of the Washington Post so clearly pointed out — Boeing accounted for 56 percent of the July increase and McDonald’s was responsible for 23 percent. Furthermore, Apple surprised most of Wall Street with powerful quarterly results.

These companies are performing the old-fashioned way; they are focused on delivering financial results by delivering the products, services and programs that their customers want. A reading of the news releases coming out of Boeing over the past year provides a list of deal after deal being announced on new planes and new models of existing planes. Apple is much more than iPhones — the recent quarter was all about iPad and Mac. Meanwhile, McDonald’s continues to drive increases in profit margins.

These companies focus day in and day out on delivering financial results to their shareholders. They have to get second-by-second report feedback from their owners every moment of every trading day and they deliver a report card on performance every 90 days. These companies, and all public companies and their investors, do not ignore what happens in Washington, London or Beijing, but they are not paralyzed by it either. The public markets are more concerned with fundamental company performance and certainty than anything else.

The GOP is at war with itself, and the Republicans and Democrats are in a continuous state of gridlock, therefore most of Wall Street doesn’t pay much attention to D.C. because there is no action, just more talk. Interest rates continue to be low and signals from the Fed indicate no major changes coming.

Rising indexes reflect rising stock prices, and that is a good sign, as long as there is not a disconnect with the underlying fundamentals of the companies (think the big disconnect between underlying company price-to-earnings ratios during the tech boom and bust in 1998-2000) which isn’t the case here at all. 

As we watch stock market barometers rise and fall, we need to keep in mind what they actually measure. The stock market is not the same as the economy, but rather a segment of it. Unemployment, GDP, interest rates, tax policies, balance of trade, etc., are all additional metrics that help us understand the performance of the economy. We should not equate the performance of a handful of companies with the overall state of the economy.

John Jacobs is a distinguished policy fellow and executive director of the McDonough School of Business’s Center for Financial Markets and Policy at Georgetown University. He’s a former Nasdaq executive and creator of QQQ, a widely-held and traded exchange-traded fund (ETF) that tracks tech companies. 

The views expressed by contributors are their own and not the views of The Hill.