Fool.com: The Dow Under Fire (Foolish Four) December 17, 1998

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Alexandria, VA (December 17, 1998) -- We've seen a flood of negative earnings releases from some Dow companies in the past week or so, and our Foolish Four stocks have fallen further and further behind the Standard & Poor's 500 Index. So what's going on?

Dow investors should know better than to hit the panic button. A long-term approach is necessary with Dow Investing. But there are some nascent trends that look interesting.

For example, for the past two years the Foolish Four is not just trailing the S&P 500, but the whole Dow Jones Industrial Average is trailing the S&P by a significant amount. In 1997, the Dow gained "only" 22.6% to the S&P's 31%. As of December 15th of this year, the S&P was up 19.82%, while the Dow had increased 11.57%. Barron's Online argued in a recent article that this reflected a split between the Dow's primarily industrial companies and the S&P's largely high-tech and pharmaceutical companies. As a result, while S&P companies like Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>, Cisco <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %>, and Dell <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: Dell)") else Response.Write("(Nasdaq: Dell)") end if %> are doubling and tripling in value this year, Dow companies like Caterpillar <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAT)") else Response.Write("(NYSE: CAT)") end if %>, Union Carbide <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UK)") else Response.Write("(NYSE: UK)") end if %>, and Minnesota Mining and Manufacturing <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MMM)") else Response.Write("(NYSE: MMM)") end if %> are issuing earnings warnings.

It's certainly true that Dow companies, being mostly multinationals exposed to weak economies abroad and the strong dollar, are reporting earnings shortfalls almost daily. Coca-Cola <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %> recently announced that its fourth quarter results would come in below already reduced Street estimates; Union Carbide indicated that not only would its fourth quarter earnings fall short of expectations, but that it would also miss its 1999 earnings target of $4 per share by a long shot. Analysts' consensus estimates for Union Carbide's 1999 earnings are at $2.47 a share instead. Finally, 3M and Caterpillar have also announced lower earnings for the upcoming fourth quarter, and DuPont <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DD)") else Response.Write("(NYSE: DD)") end if %>, J.P. Morgan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JPM)") else Response.Write("(NYSE: JPM)") end if %>, Sears <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: S)") else Response.Write("(NYSE: S)") end if %>, Boeing <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BA)") else Response.Write("(NYSE: BA)") end if %>, and even Merck <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MRK)") else Response.Write("(NYSE: MRK)") end if %> have also stumbled in recent weeks.

Given the disparity between the two indices, which is unusual historically, it's tempting to say that the Dow is just not keeping up with our fast-moving economy, but that may be too simplistic. As discussed in our Foolish Four primer, the stocks that make up the Dow are selected by the editors of the Wall Street Journal. They have worked to keep the index modern, with a new stock being added every three years, on average, since the inception of the index. Just last year, for example, Woolworth, Bethlehem Steel, Westinghouse, and Texaco were replaced by Wal-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %>, Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>, Johnson & Johnson <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JNJ)") else Response.Write("(NYSE: JNJ)") end if %>, and Travelers Group -- now Citigroup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: C)") else Response.Write("(NYSE: C)") end if %>. This reduced the number of older, industrial stocks and increased the representation of the high-tech, retail, financial, and pharmaceutical sectors. In 1992, Walt Disney <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DIS)") else Response.Write("(NYSE: DIS)") end if %>, Merck, and J.P. Morgan were added, in place of Primerica, Navistar, and US Steel. (For the current list of the Dow 30, click on the "Today's Stock Lists" link below).

Perhaps the gap between the two indices is the result of other factors. Barron's ascribed it partly to "investors... rotating into strength from weakness," strength in this case being represented by major drug and tech stocks and weakness being the "faltering multinational and cyclical stocks" in the Dow.

In addition, it was recently reported in The Wall Street Journal (and on CNNfn's website) that the Vanguard 500 Index fund may surpass Fidelity's Magellan fund as the largest mutual fund, perhaps late next year or in 2000. Magellan has approximately $76.29 billion in assets, with Vanguard's 500 Index about $7 billion behind. While it's impossible to determine the impact of indexing precisely, clearly such inflows are having some impact on the S&P overall. On the other hand, much of the S&P's performance this year comes from its top 20 or so stocks, so it may be that the S&P simply has some hot growth stocks.

Contrast this with the Dow, which will never be a "growth index." The Dow companies are expected to be industry or sector leaders, but as the Dow Jones website notes, "It isn't a 'hot stock' index...." Currently, all Dow stocks pay dividends, for example, which fast-growing companies like the Ciscos, Microsofts, or Dells usually don't do. They prefer instead to plow their earnings back into the company to finance more growth.

Whether this gap between the two indices will last is no more predictable than the market itself. But if the Dow continues to lag the S&P, won't this make it harder for investing strategies based on the Dow to beat the S&P 500? Possibly, but these discrepancies have occurred before, and the differences have smoothed out within just a few years.

Of course, there are S&P versions of our Dow Strategies. Over in the Foolish Workshop, Ethan Haskel writes a column every Wednesday on Beating the S&P. But before we all adopt the S&P as our index of choice, let's remember that so far, its lead over the Dow is pretty temporary and may amount to no more than a blip a few years from now. It's also quite possible that a change will occur in the next year or two. Some of the Dow laggards may merge with other companies or be replaced in the index with better-performing stocks. After all, the Dow won't want to be shown up by the S&P forever.

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Current Dow Order | 1998 Dow Returns

12/17/98 Close

Stock Change Last -------------------- UK +2 3/16 42.44 IP + 1/8 41.50 MO - 5/16 53.13 EK + 3/8 73.44

Day Month Year FOOL-4 +1.22% -3.23% 10.45% DJIA +0.97% -2.64% 12.23% S&P 500 +1.55% 1.40% 21.59% NASDAQ +1.72% 4.84% 30.15% Rec'd # Security In At Now Change 12/31/97 206 Eastman Ko 60.56 73.44 21.26% 12/31/97 276 Philip Mor 45.25 53.13 17.40% 12/31/97 291 Union Carb 42.94 42.44 -1.16% 12/31/97 289 Int'l Pape 43.13 41.50 -3.77% Rec'd # Security In At Value Change 12/31/97 206 Eastman Ko 12475.88 15128.13 $2652.25 12/31/97 276 Philip Mor 12489.00 14662.50 $2173.50 12/31/97 291 Union Carb 12494.81 12349.31 -$145.50 12/31/97 289 Int'l Pape 12463.13 11993.50 -$469.63 Dividends Paid YTD $1092.81 TOTAL $55226.25

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