Stock-market indices offer an alluring impression of rigor and certainty. But what do they really mean? The University of Michigan political scientist Arthur Lupia and five colleagues argue in the January 2011 edition of Political Communication that the Dow Jones Industrial Average (though they could have picked the S&P 500, NASDAQ-100, or others) misrepresents the value of stocks relative to other things one might invest in—foreign currencies, gold, real estate, art. Taken by itself, the DJIA is misleading.
Journalists know that, including those at The Wall Street Journal, which invented the DJIA in 1896. (To this day, the Journal’s managing editor selects which companies’ stocks go into the index, along with the head of research at Dow Jones Indexes and the head of research at CME Group, the Chicago-based company that in 2010 purchased 90 percent of the Dow Jones Indexes business.) On the front page of the Journal, below the name of the paper and above the headlines, a line lists yesterday’s closing values for the DIJA, NASDAQ, Nikkei, STOXX 600, Ten-Year Treasury Yield, the price of oil, the price of gold, and the value of the euro and the yen relative to the dollar. Hint to WSJ readers: don’t rely on one measure alone.
But should it be more than a hint? Lupia thinks so. As does CJR’s Ryan Chittum, who reported in a January 5, 2010 post for The Audit, our online business desk, that if you don’t adjust stock indices for inflation, their changes—mostly upward in recent years—overstate the benefit of investing in stocks. (Chittum drew on E. S. Browning’s December 28, 2009, Wall Street Journal story on the topic.)
Lupia et al. agree with Chittum’s conclusion, but, instead of using inflation to adjust the DJIA, they use the changing value of the dollar. People take the DJIA to be a number of solidity and grandeur, but it simply refers to the amount in US dollars one would need to purchase a given set of stocks, and the value of the dollar constantly fluctuates relative to other currencies. (The authors call the failure to link the DJIA to the changing value of the US dollar “point blindness.”)
So, although the DJIA rose 32 percent from 2002 to 2007, its gains significantly shrink when adjusted for the value of the US dollar, which fell relative to twenty-four of twenty-six other leading currencies, declining an average of more than 29 percent. To use Lupia’s example, if you invested $10,646 by buying one share of the DJIA as it was priced on January 2, 2001, by the end of 2008, your investment would have grown to $11,199. However, if you had instead invested your $10,646 in Canadian currency and put the Canadian dollars under your bed, you would have ended up with $13,020—four times the gain.
Elementary, right? But the point is rarely made. Lupia and his colleagues looked at the New York Times’s news coverage during the last quarter of 2006 when the DJIA reached twenty-one record-high daily closings while the dollar declined sharply relative to other currencies. Of the fifty stories with “Dow” in the headline or lede two days after a record Dow high, only one (a column by Floyd Norris) noted the declining value of the dollar as a context for understanding the significance of the Dow’s rise. The fifty articles were accompanied by twenty-eight graphics that showed DJIA data, but none of the graphics related the data to exchange rates.
Lupia’s study demonstrates that even the Times, a stalwart in business reporting, is afflicted by “point blindness” and, in turn, helps to fuel it. So why does business reporting so often fail to include a relevant international context for understanding stock-market values even when the business press is increasingly attuned to the movements of the global economy? Does it result from a kind of narcissism of the US dollar? Or from a number magic that traps reporters along with everyone else? Or from an unacknowledged belief that investors should put their money where it may help business growth, and not under the bed where it won’t?
The stock indices are proxies for the “economic value of stocks,” but they would be better proxies if adjusted for the global value of the dollar or for inflation.