Dow Jones Industrial Average Hits New High

Chart of the Week for October 13-19, 2006

A strong U.S stock market rally in October helped the Dow Jones Industrial Avearage (DJIA) break through its historical high level from January 2000. During the past week, the index has been setting new highs and closed Thursday at a new record of 11,947.

Although the DJIA is a widely followed stock market index, we can understand its biases by taking a look at its construction. It is a price-weighted average, which gives higher-priced stocks more weight than their lower-priced counterparts. This can produce misleading results, as a $1 increase in a lower-priced stock can be offset by a $1 decrease in a much higher-priced stock, even though the first stock experienced a larger percentage change. Additionally, only 30 stocks are in the index, a relatively small number considering the DJIA is widely used as an indicator of overall market performance.

Some analysts also cite that inflation has taken a bite out of the purchasing power of the DJIA since the last period it made a record high more than six years ago and that the index needs to pass 14,000 to hit the old record in real terms. Analysts also feel that since the dollar is weaker today than six years ago, this record for the Dow doesn’t carry the same significance in a global context.

This reminds us that when the media reports index news, investors shouldn’t chase performance. Keep a long term perspective and diversify your investment portfolio.

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