Things are looking up for Dow

Last week was the fifth anniversary of the collapse of the investment bank Lehman Brothers, an event that signalled the start of the financial crisis, an issue that to this day dominates media headlines and governs monetary and fiscal policy in most advanced economies.

But here's one for the equity bulls: if you'd held on to your shares through the crisis, you'd be doing pretty well. Far better than if you'd sold them and held on to the cash. If you added to your portfolio in December 2008, you'd be up considerably, but if you were brave and smart enough to top up in March 2009, when the market bottomed, your returns would be nothing short of spectacular.

During last week the JSE's All Share Index reached a fresh peak. So far this year the index has advanced over 10%, not as exciting as last year's plus 20% gain, but still respectable considering the troubles distressing our country and the broader world economy.

Remembering the fall of Lehman wasn't the only news item to occupy the headlines on world markets. The other was the shake- up of the iconic Dow Jones Industrial average, the biggest since 2004. Axed were downstream Alcoa, Bank of America and Hewlett-Packard. Included were Nike, Goldman Sachs and Visa.

Although the Dow is no longer as relevant as it was a century ago, it is still one of the most widely watched measures of the US stock market.

Created by Wall Street Journal editor Charles Dow and statistician Edward Jones in May 1896, the index was intended to include companies that represented the breadth of the US market. The first index was symbolic of the industries that ruled at the end of the 19th century among which were sugar, tobacco, cattle feeding, leather, gas and rubber enterprises. The current average is made up of 30 stocks covering oil, financial, technology, consumer, pharmaceutical, health and industrial corporations.

Without the multiple electronic devices that allow us to instantly perform thousands of intricate computations at the touch of the button, the Dow was originally designed to be a simple gauge of how the market was doing, calculated by adding the prices of the components and dividing the sum by the number of constituents. The custom continues to this day, although the divisor is constantly adjusted for individual stock splits and other structural changes. The process is deeply flawed.

For example, IBM's share price at $180 counts four times as much as Coca-Cola at $40, even though both companies have roughly the same market capitalisation. Oddly, two of Wall Street's corporate giants, Apple and Google, are not part of the Dow. Apparently their prices are too high and including them would warp the index.

These obvious distortions have driven professionals to follow the more recognised S&P500 as an assessment of Wall Street's performance, an index weighted on size and importance. While investment funds tracking the S&P500 have attracted $1.6-trillion, the Dow is way behind with $30-billion emulating its performance.

Notwithstanding its shortcomings, the Dow remains a vital part of American culture. Momentous historical events will always be quantified in terms of its performance. The first published price was 63. In the 1920s the average rose to 380, but with the 1929 market crash and ensuing depression the Dow surrendered more than 90% of its value, and took more than 20 years to reclaim its lost ground.

Last week's changes to the constituents were prompted by a combination of under-performance and the desire to diversify sector and industry group representation of the index. Performance of the newly composed index should be very different from now on. With the US economy flexing its muscles again, the upshot of increased housing and share prices and the regeneration of consumer confidence, analysts are pencilling in 20000 - more reason for the bulls to cheer.