The Dow Explained (And Why I Hate It), Oil Gets Slammed, And Much More
StreetSmarts Morning Note
"In the short run, the market is a voting machine, but in the long run, it is a weighing machine."
-Benjamin Graham
"The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions."
-Seth Klarman
Table of Contents
A.M. Allocations: Summaries of important news and investing events
Pres. Biden Bets Big On Loan Repayment
Mortgage Demand Drops Even Lower
Banker Cuts At Barclays
Hackers Behind Casino Capers Believed Behind Clorox Heist
Progress Made In Auto Strike Negotiations
Crude Oil Prices Fall, Dented by Lower Demand
Hot Headlines: Links to some of the top financial stories of the day
What Is The Dow? (And Why I Hate It) [Cover Story]
A.M. Allocations
Pres. Biden Bets Big On Loan Repayment - President Joe Biden's recent announcement of $9 billion in student loan forgiveness for 125,000 Americans has caused quite a stir. The relief includes funds for public service workers, those on income-driven repayment plans, and borrowers with disabilities. Experts suggest that this move could boost Biden's chances in the upcoming election, as he's now been dubbed the "student debt superhero" by forgiving more student loan debt than any previous president and basically going full-on-Oprah. CNBC Link.
Why it matters: Loan forgiveness could buy Biden some election love and also frees up spending power for those strained with debt. It also might be a sign that Biden is flexible on student loans if we should find the US in a recession next year.
Mortgage Demand Drops Even Lower - Mortgage rates are soaring, leading to a 6% drop in mortgage demand. The average rate for 30-year fixed mortgages hit 7.53%, up from 6.75% a year ago. Refinancing applications fell by 7%, making up less than a third of total applications. Home purchase applications dipped by 6%, reaching their lowest level since 1995. Adjustable-rate mortgages (ARMs) are making a comeback, accounting for 8% of purchase applications. Meanwhile, the 30-year fixed-rate average hit 7.72%, driven by investor reactions to strong economic data that might prompt the Federal Reserve to raise interest rates. Current and prospective homeowners, brace yourselves—it's a turbulent ride in the mortgage world! MBA Report.
Why it matters: The drop in mortgage uptake is another sign that high interest rates are starting to have a negative impact on the everyday consumer, and that the US’ economic prospects are deteriorating.
Banker Cuts At Barclays - Barclays is trimming its investment banking workforce by 3% in a bid to streamline operations after a tumultuous year. Around 300 employees may face layoffs, with a focus on trading, research, and technology investment banking in San Francisco. Despite recent reforms and hiring, Barclays remains 6th in the global investment banking league table, as it strives to find its footing in the competitive market.
Hackers Behind Casino Capers Believed Behind Clorox Heist - The infamous hacking group "Scattered Spider," known for their audacious exploits targeting major casinos (Caesars Entertainment Inc. and MGM Resorts International were hacked in September, crashing almost everything including the slot machines), has expanded their repertoire. Suspected to be behind a recent cyberattack on Clorox, their social engineering tactics involve infiltrating call centers and IT help desks by impersonating employees to access valuable information. While their previous hacks made headlines, their assault on Clorox has had even broader consequences, leading to a nationwide shortage of cleaning products and significant profit drops. The attack's specifics, such as the use of ransomware, remain shrouded in mystery as the FBI conducts its investigation. Bloomberg Article.
Progress Made In Auto Strike Negotiations - United Auto Workers (UAW) and Ford Motor have reportedly made progress on pay increases following a fresh offer from the automaker, with talks described as "really active." UAW President Shawn Fain is set to update the union's 150,000 members at Ford, General Motors, and Chrysler parent Stellantis on Friday, though it remains uncertain whether he will call for further walkouts or announce sufficient progress to delay additional strikes. Talks with Stellantis and other automakers have also been active recently. While Ford's latest offer includes a more than 20% general wage increase, other significant issues like pay, union representation at future battery plants, and retirement plans remain unresolved. Reuters Article.
Why it matters: The auto sector has an important impact on GDP by the sheer size of it, both directly and indirectly (thousands of suppliers). This also sets the tone for labor negotiations across the auto space and more broadly (such as the 75k Kaiser Permanente employees that just walked-off the job.
Crude Oil Prices Fall, Dented by Lower Demand - The US benchmark for oil dropped 5.6% in its largest single day drop in over a year as the demand picture quickly turned murky. WSJ Article.
Joke Of The Day
Boss: "How good are you at PowerPoint?"
Employee: "I Excel at it!"
Boss: "Was that a Microsoft Office pun?"
Employee: "Word."
I told my wife I wanted to start a business.
She said, "Are you going to be the boss?"
I said, "Yes."
She said, "Well, you already have one boss... so now what?"
<3 Kelly
Hot Headlines
(Reuters) Global bond rout deepens before receding on relief rally
(Barron’s) Math Nerd's Billion-Dollar Oopsie: Crypto Empire Built on 'Innocent' Missed Memos
(Reuters) Meta to lay off employees in metaverse silicon unit on Wednesday
(CNN) UAW strike cost GM $200 million in its first two weeks
(Bloomberg) Google Takes on Apple With New Pixel That’s More Like the iPhone
(Barron’s) Tesla Stock Is Surging. Thank the EV Bears
Trivia
Before 2006 when the New York Stock Exchange became a for-profit organization, the only people allowed to execute trades over the exchange had to hold a ‘Floor Seat’ - effectively a prestigious membership with the organization. Adjusting for inflation, what was the highest price paid for a ‘Seat’ on the exchange?
~$35 million
~$3.2 million
~$6 million
~$2.9 million
What was installed in the gallery of the New York Stock Exchange in 1967?
A Monet
Bullet-proof glass
A statue of the god Jupiter
A Bull fresco
(answers at bottom)
What Is The Dow?
And Why I Hate It
If you made it all the way to the trivia section Monday, you might have caught some less than complimentary language relating to the Dow Jones Industrial Average (henceforth ‘The Dow’ or ‘The Dummy Index’)…followed immediately by a picture of Adam Sandler faux-urinating himself (you chose a classy newsletter to start your day with).
Today I’m going to highlight some of my reasons for my feelings, which should be as educational as it is vitriolic. Shall we now:
The Companies
When you hear ‘the NASDAQ did X’ you can use that to glean information on the growthy, mostly techy space. When someone says something about the S&P 500 you can rightly draw conclusions regarding the broader US market as a whole. When someone says something about the DJIA, you can think ‘ok, a bunch of old boring industrial companies, mixed with a few random healthcare companies and banks…plus, like, Microsoft and Apple’. It’s about as useful in developing a market thesis as the below:
The Dow consists of 30 companies. Neither the biggest, nor sector-specific. In fact the methodology in deciding what names to include is so arbitrary that it is actually decided subjectively by a committee at the Wall Street Journal.
While the Dow does contain a number of large companies, it randomly includes and excludes others at random. As you can see above, of the 25 largest companies in the US, only 12 are represented in the Dow.
Looking at it another way, it includes the two largest companies in the US - Apple and Microsoft - but also the US’ 217th and 341st largest companies. WHY? SOMEONE TELL ME WHY!
The Weights
Arguably the dumbest thing about the Dow is the way it determines the weightings for the index. The S&P 500 - and indeed, most logical indices - are weighted by market capitalization (eg: if you sum up the total value of all the companies in the S&P 500, Apple’s market cap is 7.2% of the total, and thus Apple has a 7.2% ‘weighting’ in the index). On the other hand, the Dow is… ‘price weighted’. Add up the share price of all the companies listed, and divide it by a number, called the ‘Dow Divisor’ (more on that later) and that’s the index value.
If it isn’t immediately clear why that’s a problem, imagine a theoretical price weighted index with two companies with the same market cap: Company A’s share price is $700 and Company B’s is $14. Even though the companies are the same size (same market cap), Company A would have a weighting of 98%.
The above illustrates the oddness of it all. Apple is 1/4 of total companies by market cap but has a 3.4% weight. Caterpillar is 2.8% of the total market cap but has a 5.4% weight.
The ‘Dow Divisor’
Because the index is price weighted, a $1 movement in Caterpillar has the same impact as a $1 movement by any other company. The impact of a $1 move on the value of the index is determined by the Dow Divisor, which is currently 0.152064031872367. So, a $1 movement by Apple causes the index to move 6.57617707282244 points. You can’t make this stuff up.
The main reason for the divisor is to compensate for superficial changes in the value of a company, most notably ‘stock splits’. If Apple does a 3:1 stock split tomorrow its share price will change from $171.21 to $57.07. Because the Dow can’t go down as a result (because it’s price weighted), the Dow Divisor changes so that the index value isn’t affected - and the new Dow Divisor will update to a nice round 0.148650075448616. Even better is that if this happens, Apple’s weight in the index will drop from 3.4% to 1.1%.
Conclusion
The fact that people still cite the Dow (and yes, I’ve included it here and there - usually tucked way at the bottom, so I am part of the problem by pandering) is pretty crazy to me. Just stick to using the Nasdaq or S&P 500. Or, be one of the cool kids and reference the FAANG ‘Magnificent 7’ (not the Denzel movie).
TLDR: There are objective flaws in the way that the DJIA is calculated that limit its applicability as a reference for financial markets. And you should also hate it.
Market Update
Main Indices
Trivia Answers:
~$6 million. In 1929 a Seat was sold for $625,000 which is around $6 million in today’s dollars. The stock market imploded shortly after on October 24, 1929 (“Black Thursday”), helping to trigger the Great Depression. Seats were trading as low at $17,000 by the 1940s. Ouchy!
Bullet-proof glass. It stemmed from a prank by a group of activists led by Abbie Hoffman, where they went into the gallery overlooking the trading floor and threw fist-full of dollars (some real, some fake) onto the traders below.
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