Culture

The Great Dow Jones Myth


Every TV and Internet news program reports the state of “The Dow,” a reference to the Dow Jones Industrial Average index. Yet no one questions the relevance of that information. What has it to do with our everyday lives? Does it accurately measure success and failure; and if so, whose success or failure? Is it accurate at all? Who created the norms and standards of measurement? Who benefits from this knowledge? Is the condition of the stock market a valuable basis for public policy and allocation of resources?

Before the 1980s the public only heard about activity of stocks that were included in the Dow, and most likely traded on the New York Stock Exchange (NYSE). Occasionally they’d mention the condition of other stock indexes such as the S&P 500 (formerly Standard & Poor’s 500). Nowadays those have been joined by reports on NASDAQ and, for the sophisticates among us, the Nikkei of Japan, the London Stock Exchange, and many others. This ongoing reportage leads many to believe that these numbers are measures of our nation’s, or world’s, economic health. If the stock market numbers go up, all is well. If they begin to fall, drastic measures are required to keep our economy alive. Or so goes the lore. Yet few people seem to ask the most basic questions about this shared myth. How did it begin? How does it really work? Why should we care? This is my attempt to unravel those mysteries.

It’s important first to understand the basic structure of our economy. In most basic terms, whenever someone wants to trade a good or service for money in our country, they must first obtain a license in their state and, often, local jurisdiction such as city or county. By obtaining that license they enter into an agreement with the citizens of that jurisdiction to abide by the agreed-upon principles codified in the laws of that locale. For example, if the citizens, through their elected officials, have decided that pollution of their waterways is unacceptable under any circumstances, the person or people obtaining a license are agreeing that they will not pollute the water. If the citizens of a state and/or city have agreed that child labor is unacceptable, the person or people obtaining a license agree(s) they will not use children in their business endeavors. No one is allowed to do business within a state without obtaining a license. That license is authorization, conferred by “We The People,” to engage in commerce. It is also a promise the company makes to meet the standards of the laws we have enacted through our representatives.

There are several types of business licenses, but for the purpose of this article I will focus on one: the corporation. Each state defines the structures, rights, and responsibilities of a corporation. For this article, I will focus on those corporations that can issue stock.

So now the questions begin. First, what is The Dow? In short, it’s a calculation based on a list of 30 companies deemed to be reflective of the health of their sector of the U.S. economy. More detail on this later.

Next, what is stock? A stock certificate is a document reflecting a financial investment made in a company in exchange for partial ownership and a promise of future financial returns based on the company’s economic success. If I own a hair salon and want to expand it, but don’t have the needed $10,000, I can offer stock in my company. Those who purchase the stock receive a certificate giving them claim to a percentage of ownership in my hair salon and a portion of any profits equal to that percentage. You give me money today, I promise to give you a portion of my profit at agreed-upon times in the future. The more profit I make, the more money you get. Of course, it’s also true that if I make no profit, you get nothing.

The initial price of my stock is based on the value of my company at the time I require the investment. This is where the fun begins.

The value of a stock is based on the value of all of the assets the company owns, monetary and otherwise, as well as its projected annual earnings and current as well as projected expenses. It sounds so simple. Let’s get back to my hair salon. I don’t own the building the salon is in, I rent the space for $2000 a month, so that’s an expense. I do, however, own the six styling stations and chairs, two shampoo chairs, the sinks and all the fixtures, the plants, the brooms and mops, the iPad cash register, and the tables and chairs in the waiting area. They’re worth a total of about $25,000. Of course, I don’t actually own own them, because I bought them on credit, so I only own the percentage reflecting the payments I’ve already made on them. If I had to sell them, I would have to pay off the creditors first before anything is left over as profit.

If I had employees, I’d need to figure their salaries and benefits (medical, vacation, etc.) as part of my projected expenses. As a salon owner, however, I don’t have employees. Like most other salons, stylists rent my styling stations on either a monthly basis or in exchange for a percent of their business income. In this example, I receive an average monthly income of $800 from each stylist. This is part of my projected income. The $10,000 I need would allow me to add two more stations, thus increase my income.

Additional expenses would include the lease payment, utilities, insurance, wholesale prices of products I might sell to or use for the customers, and equipment lease or credit payments.

The value of my business is made up…I mean, uh…”determined” based on all of those calculations. Okay, I really do mean “made up.” Why? Because the numbers called “projections” are actually just calculated guesses. They are what the calculation thinks might happen in the future. It’s certainly possible to create a calculation based on what happens in other, similar, businesses, but that, too, is a guess of what will happen with mine.

What happens if one of the stylists decides suddenly to move out of state and his station sits empty for two months while I find a replacement? What if a tornado takes off my roof? What if I become ill and can’t manage the salon for six months? What if the city decides to rebuild the street in front of my business and reroutes traffic in such a way that no one can get to me? What if a group of Wall Street traders crash the economy and all of my customers lose their homes? What if Martians finally invade? What if my husband and his mistress clean out my bank account and run off to Granada? There is no way to calculate those contingencies. Yes, it’s possible to include an “in case of emergency” calculation, but it has to be made up too, because no one can accurately predict the future. A perfect example of this is IBM’s history with the Dow.

IBM (formerly International Business Machines) first became a Dow company in 1932. It fell off in 1939 then was added again in 1979. It has been a Dow company ever since. Even in the late 1980s and early 1990s, when IBM nearly went under, they were still included in the Dow, while the companies like Cisco, Intel, Microsoft, and Apple, that were at the root of the technological revolution, were not. Another example: AIG, the company at the core of the 2008 economic meltdown, was on the Dow until the day it nearly brought down the entire country.

In addition to these guesses, there are assets and expenses that are never included in a company’s valuation: the cost and benefit of having my spouse be my nanny, housekeeper, or dog walker; the meal service that feeds my family every evening so that I can work late; the vibrant community organizations that bolster my customer base; the clean, well-lit streets around my salon; the strength of my extended family ties that will pitch in when things get tough, the loyalty of my colleagues, the amount of time I spend doing community service and networking.

This example uses just one little hair salon. Imagine the made up “projections” of a large corporation! I worked for RepublicBank Dallas when its senior management called a late November 1986 press conference. All the managerial employees were shepherded into a downtown theater. Knowing that the company was in deep financial trouble, staff expected to be told about massive layoffs. Instead, the bank’s Chief Financial Officer (CFO) stood before an array of news cameras and microphones and declared the strength and solvency of the bank, while admitting they were going through rough times. Within six months the bank was taken over by Federal agents and all of its assets liquidated. The CFO’s false information stabilized the stock price long enough for many senior executives to leave the company and convert their stock into cash before the collapse. Lucky for me, a lowly cog in that massive organization, I followed my instincts and left shortly after that press conference.

Since 2008 I’ve noticed similar behavior from major, national retailers that have steadily cut their workforce in order to reinforce their company valuation in order to increase their stock prices and the dividends to their stockholders. Since employees are expenses, cutting them immediately boosts valuation. However, they often also make the best customers, so making them jobless decreases their spending (not to mention makes them less likely to buy from their former employer). These retailers, rather than admitting their products are no longer making profit, end up cutting off their arms and legs in order to feed their bloated internal organs, then express shock at the economic carnage all around them.

Stocks were originally created so that people with excess money could help new or growing companies by providing financial resources to spur or strengthen their business. The majority of people in society owned no stock because they seldom had excess funds beyond, perhaps, a small savings account. Moreover, few had the time or other resources to investigate the actual worth of a company and determine whether they were getting an accurate price for their investment. Even today, super-investors like George Soros and Warren Buffett have extensive teams of researchers who study all potential investments and go beyond the obvious numbers to assessing the “intangibles” such as history and strength of current and potential corporate leaders, the stability of the company’s workforce loyalty, the commitment to adaptation and innovation, the reward for risk and tolerance for failure.

Until the mid-1980s, one of the best benefits a company could offer an employee was a pension plan: a supplementary savings plan managed by the company and held in reserve for the employee until her/his retirement or separation from the company. Each corporation had its own rules on how the pension was determined and allocated as well as how many years one had to work to earn the right of a partial- or full-pension.

In the mid-1980s, however, a benefits consultant named Ted Benna realized that a recent change in the tax code could allow individuals to create their own retirement accounts. Section 401(k) permitted deferred taxes on money saved for retirement. An entire industry then grew to manage the billions of dollars saved in 401(k) accounts. Rather than let the money sit quietly accruing interest like a straightforward savings account, those managers began aggregating it and using it to invest in corporate stock. Individuals who knew nothing about how to gauge the value, or even credit worthiness, of a company suddenly had their retirement savings invested in companies they knew nothing about. For the first time in history, the investor had no direct relationship with the investment; in fact the actual investor may not even have a relationship with the person managing their money. Most companies converted from pension accounts to 401(k) and turned over the management of the accounts to financial management firms with little to no input from the employee, whose money it was.

To add to this little game, the stock exchanges themselves are rigged. For example, the Dow tracks the performance of 30 companies deemed to be the primary drivers of the US economy. Editors of the Wall Street Journal make that decision based on the high level of trade in each company’s stock. The first tech companies, Microsoft and Intel, were added to the Dow in 1999, nearly fifteen years after their revolution of desktop computing and nearly at the end of the first tech-based financial boom. Cisco Systems was added in 2009, and Apple in 2015! WalMart was put on the Dow’s list in 1997, but Amazon has never been listed on the Dow. It has been listed in the Standard & Poor’s 500 (S&P 500), but its activity has never been used to calculate the Dow.

And then there are the numbers themselves. What does it means that “the Dow is over 20,000”? Does it mean $20,000 worth of stock was traded that day? How about that 20,000 trades were made? Or the average value of a stock trade was $20,000? Nope. None of the above. Let’s let Wikipedia explain:

The value of the Dow is not the actual average of the prices of its component stocks, but rather the sum of the component prices divided by a divisor, which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index. Since the divisor is currently less than one, the value of the index is larger than the sum of the component prices. (emphasis mine)

Simply put, the “average” is actually not an average at all. It simply adds up the price of one share of stock from each of the 30 companies on the Dow’s index and divides it by a magic number that changes depending on corporate decisions to either split the stock or issue a dividend. Since the editors of the Wall Street Journal determine which companies’ stocks are used to calculate this number, they can easily manipulate it so the result continues to rise.

I can just hear some of my financial management friends right now. They are screaming that I just don’t understand. They’re telling me that the formulas are tried and true. I just need to have faith.

Um, no. How accurate can the Dow’s measures be if the companies it uses as norms don’t reflect the current engines that drive the economy? How much faith can we put in their proclamation of our society’s economic health? And if the formulas (aka algorithms) are so accurate, why was it only the crazy lefty social scientists that saw the Dow’s collapse in 2008 coming? How was it that the Dow’s number boomed back even as the housing debacle created homelessness at a level unseen since the Great Depression? How is it that cities like Detroit and Flint have been relegated to death heaps while the Dow climbs ever skyward?

What the Dow actually measures is the successes or failures of 30 large companies to make money for their investors. The impact of those companies’ actions on the majority of our lives is irrelevant. That Wal-Mart can promise its investors between $65-$70 per share of stock while simultaneously paying its workers below-poverty wages, impoverishing them and their communities, is endemic of the actual value of the Dow. It’s worthless. In a democracy that demands accountability of its corporations, the public good ought to supersede the policies and practices of a corporation, and Wal-Mart’s license to do business ought to be revoked in every state where it continues to hold its employees in thrall.

If we’ve learned anything from the financial debacle of 2008, it ought to be that there is more to a healthy economy than is reflected in the stock prices companies. In the late 1970s economic futurist Hazel Henderson challenged economists to find more relevant ways to quantify the condition of a society. She and a multi-disciplinary team eventually developed a systems-based gauge. The Calvert-Henderson Quality of Life Indicators measured twelve social systems: education, employment, energy, environment, health, human rights, income, infrastructure, national security, public safety, re-creation, and shelter. Unlike the Dow or other corporate-based indexes, these indicators include the impact of systems on everyday people. These measures have been adapted by graduate schools such as Pinchot University (formerly Bainbridge Graduate Institute) that now teach a triple bottom line for corporations: social, environmental, and financial impacts. What a different world we would live in if the evening news gave us a status report reflecting those, rather than just the status of corporate dividends to investors. Imagine entire companies springing up to measure the twelve social systems and propose policies and practices to enhance them. Imagine the dynamic dialogue at city halls and county council meetings around our country. Imagine the transparency required. Imagine.

Lola E. Peters is a writer living on the Great West Seattle Peninsula. She does not own a hair salon, but she does imagine.