The Dow vs. the Rest of the Market

The Dow Jones Industrial Average (DJIA) quietly shot past all the other benchmarks in October, and no one expected that.

The DJIA is the benchmark most quoted by the media, but it takes a lot of abuse from academics and financial professionals. The DJIA reflects the limits of technology at the time it was created 121 years ago.

Charles Dow needed a market benchmark that could be calculated accurately in time for a daily publication deadline in the days before calculators and computers. Only 30 stocks are used to compute the DJIA, and they aren’t representative of the economy or overall market.

The benchmark isn’t capitalization-weighted the way the S&P 500 and most other indexes are. It isn’t even equal-weighted. Instead, it is price-weighted. The stocks with the highest share prices have the greatest impact on the DJIA.

Yet, recently the relic has been a good place to be invested. While the S&P 500 might set a record for new highs in 2017, the DJIA already has. The DJIA has closed at a record high 54 times in 2017.

In October, the DJIA gained 4.3% while the S&P 500 rose only 2.2% and the Nasdaq Composite climbed 3.6%. That is the DJIA’s largest monthly margin over the S&P since November 2008. For the year, the DJIA is ahead of the S&P 500 by almost four percentage points in 2017. That’s the largest margin since 2011, and it could beat that by the end of the year at the current pace.

Earnings growth of the DJIA is likely to be higher than earnings growth for the S&P 500 for the third consecutive quarter. The DJIA earnings are likely to increase 6.3% for the quarter compared to 4.7% for the S&P 500.  

Three factors are causing the outperformance of the DJIA.

The DJIA is composed primarily of large multinational companies. These companies are benefitting the most from the following three trends.

Synchronous economic growth in the global economy is a major factor. Most economies in the world are growing, and many are expanding at their fastest rates since the financial crisis. A global company does better in this environment than a company that depends primarily on the economy of one country.

Though the dollar rebounded in the last month or so, it has been very weak most of 2017. That also helps global companies that are based in the United States. The weaker dollar makes their goods less expensive to foreign buyers than they were last year.

The DJIA also has a lot of “old economy” companies that are doing well this year. Boeing is leading the DJIA with about a 70% return for the year. Caterpillar is up over 50%. Other companies with strong returns for the year are Intel (28%), Wal-Mart (29%), Microsoft (36%) and 3M (31%). Even McDonald’s is up 40% for the year and 7% for October.

Boeing is the largest component of the DJIA with a price of around $258 and accounts for much of the benchmark’s surge this year.

The DJIA should continue to outperform the S&P 500, as long as the environment is very favorable for U.S. exporters. If the dollar continues to strengthen or global growth slows, earnings growth might falter at key DJIA components. As long as current trends are in place, though, the S&P 500 is likely to struggle compared to the DJIA.

But if you expect the favorable trends for the DJIA to continue, you should consider overweighting your portfolio to international stocks. They will benefit from most of these trends as well. They’re also selling at more favorable valuations than U.S. stocks and have greater potential for earnings growth. You can buy a broad basket of developed country stocks through iShares MSCI ex-U.S. ETF (ACWX).

More importantly, the DJIA component companies will be hurt if the dollar rises. But the international companies still would benefit from global economic growth regardless of what happens with the dollar. If you want to take advantage of global growth without worrying about what the dollar does, buy the iShares Hedged MSCI ex-U.S. ETF (HAWX).

An actively managed mutual fund that takes advantage of these opportunities is WCM Focused International Growth (WCMRX). It buys a select few stocks that are growing rapidly and appear to be able to sustain that growth.

The Data

Consumer Sentiment, as measured by the University of Michigan, came in at 101.1, the highest month-end reading in almost 14 years. The survey was strong across the board, with consumers positive about both current conditions and the future.

Consumer Confidence, as measured by The Conference Board, rose to a 17-year high of 125.9, up from 119.8 last month. Consumers are feeling especially confident about jobs and income. We’re still waiting for these high confidence numbers to be reflected in higher retail spending. While spending increases steadily most months, it doesn’t increase at a rate consistent with consumer confidence levels.

Households continue to do well, yet inflation remains low, according to the Personal Income and Outlays report. Personal Income rose 0.4% for the month, and wages and salaries also rose 0.4%. Consumer spending jumped a strong 1%. The spending increase was distorted a bit by vehicles purchased to replace those damaged in the recent hurricanes. There also was a decline in the savings rate, which probably was also related to replacing hurricane damaged goods and a short-term effect.

The PCE Price index remains low with a 0.4% monthly increase and 1.6% 12-month increase. The core price index rose 0.1% for the month and 1.3% for 12 months.

Yet, wages continue to rise faster than a few years ago, and that should be reflected in consumer inflation at some point. The Employment Cost Index rose 0.7% for the third quarter, the third-highest reading in the recovery. It also is up 2.5% for 12 months, which is the second-highest reading of the recovery.

The manufacturing surveys issued this week were strong.

The Dallas Fed Manufacturing Survey continues to surge, rising to 27.6 from 21.3 last month. The survey held steady after Hurricane Harvey hit Houston, and now continues its recovery from the oil price collapse of a few years ago.

The Chicago PMI rose again, this time to 66.2 from 65.2. It was expected to decline a little after a strong performance last month. The report indicated imbalances are developing. In particular, manufacturers reported that employment is down because they can’t find qualified candidates for open jobs.

The PMI Manufacturing Index rose to 54.6 from 53.1. This index has been the weakest of the group for a while but reported accelerating growth the last two months. The survey was strong across the board.

The ISM Manufacturing Index declined a little, to 58.7 from 60.8. But it was at a 13-year high last month, so some decline was expected. The survey indicates strong growth. The only negatives in the report were those related to effects of the hurricanes. One example is slowed delivery times.

Manufacturing was helped by another boost in productivity to a 3% annualized rate for the third quarter. Output increased much more than hours worked. In addition, unit labor costs increased by only a 0.5% annualized rate.

Home prices continue their steady rise, according to the S&P Corelogic Case-Shiller Home Price Index. They rose 0.5% for the month and are up 5.9% over 12 months. The 12-month rate is at a three-year high for this index. This index has indicated lower price increases than the FHFA House Price Index, but both have reported steadily rising prices for houses.

Once again, the labor market data leading up to tomorrow’s monthly Employment Situation reports is strong. The ADP Employment report said 235,000 new private sector jobs were created, compared to 135,000 last month, which was revised down to 110,000. Part of last month’s lower job total are considered to be due to the hurricanes, while part of the increase in jobs this month is likely to be businesses re-opening after the hurricanes.

New unemployment claims declined another 5,000. That brings both the 4-week average and the continuing claims number to 44-year lows. This occurred despite a sharp rise in claims from Puerto Rico.

As expected, economic growth was strong in the third quarter, according to the gross domestic product (GDP) report. This was a bit higher than most economists expected but still close to the consensus. Most of the report was strong. There was some weakness in residential housing. But we’re starting to see steady increases in business investment and durable goods, which are key to sustainable growth.

The Markets

The S&P 500 returned 0.86% for the week ended with Wednesday’s close. The Dow Jones Industrial Average rose 0.44%. The Russell 2000 declined 0.12%. The All-Country World Index gained 0.93% and the emerging market equities added 1.59%.

Long-term treasuries recovered by rising 1.77% for the week. Investment-grade bonds rose 0.37%. Treasury Inflation-Protected Securities (TIPS) returned 0.50%, while high-yield bonds lost 0.36%.

The dollar gained 1.11%. It now is up 2.16% for the past three months.

Energy-based commodities gained 2.25% for the week, while broader-based commodities returned 0.89%. Gold fell 0.33%.

Bob’s News & Updates

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