Monthly Discussion



Dow's Own Little NASDAQ



As the NASDAQ phenomenon continues to preoccupy investors around the world, I want to zoom in and take a closer look at the Dow itself.

My thesis has always been that Dow's behavior resembles that of a species in nature. The 30 industrial stocks used in the calculation of the DJIA form a microcosm within the NYSE. They all are leading blue chips, household names, and united by a common identity, often posing as a single alternative to prospective investors.

It is true that there are rampant "mutations" in the stock market, whereas such mutations are rare in nature. But most stock-market mutations concern individual companies (mergers, acquisitions, stock splits, etc.). The DJIA itself remains rather insensitive to such changes, and its composition rarely changes. A significant change took place last November when Microsoft and Intel were introduced to beef up the technical component of the Dow. One can argue that an important  "mutation" of the Dow may have occurred last November.

          On the other hand, NASDAQ's onslaught has been most pronounced over the same period of time. In last month's discussion of this Newsletter we saw that the increase of market share, more accurately of stock-market share (no puns intended here) from NYSE to NASDAQ has now reached a ceiling. Moreover we hinted at the possibility of a decline for NASDAQ's share.

          Microsoft and Intel are par excellence NASDAQ stocks. If we add to them such old tech pillars of the Dow as IBM and Hewlett Packard, we end up with a mighty foursome that poses as a formidable technology component of the Dow. After all the foursome has occasionally claimed more than 50% of Dow's share volume and more than 60% of its dollar value.

          The question is what should be its size (and influence) and to what extent can it be forecasted. To address this issue I looked at the evolution of the two market shares (that of the foursome and that of the 26 others grouped together) in the competitive variables: share volume and dollar value.* 

          The two variables behave very similarly. Exhibit 3 shows the dollar-value split. I only looked at data since November 1 because Microsoft and Intel as stock-market species have probably undergone a significant mutation when they entered the Dow.

Exhibit 3.  The evolution of DOW's technical component since 1-Nov-1999. Monthly average values are shown for the first 4 months and finer weekly time bins for the last 2 months. The yellow line is an S-curve fit to the recent decline.


          Following an initial fluctuation the dollar value seems to settle at around 50% (that of the share volume around 38%). But the turbulence that began April 1st lead to a "natural" decline to 40% (30% for the share volume). Due to the fact that we have an S-shaped decline, there is argument that we are dealing with a natural phenomenon. One could argue that the 40% level established during the months of January, February, and March indicates a homeostatic natural equilibrium, in other words an "invariant".

          I disagree. I believe that 40% of the dollar value and 30% of the share volume is what Dow's own little NASDAQ is good for. Maybe this point of view is biased from my weakness for S-curves. But in any case, one would be hard pressed to find evidence for a resurgence of Dow's high-tech component. On the average for every $100 invested in the Dow, $40 will go to technology stocks and $60 to the traditional blue-chip stocks.

In other words, the "average" Dow investor will continue—if unaware—to place 40% of his or her money on technology stocks!

* The reader is reminded that unlike prices, volume and value constitute competitive variables because they are limited resources (see An S-Shaped Trail to Wall Street).