Performance of Dow Jones Industrial Average: micro and macro-level analysis Luis Palacios Rabih Moussawi Denys Glushkov Bob Zarazowski
1962 1963 1964 1965 1966 1967 1968 1969 197 1971 1972 1973 1974 1975 1976 1977 1978 1979 198 1981 1982 1983 1984 1985 1986 1987 1988 1989 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 Motivation Dow tends to hover around 1, and 1, thresholds for some time. Is it psychological anchoring of investors or there are fundamental explanations behind it? DJIA 1, 1, 1
Overlaying 1966-1982 DJIA performance with 1997-21 16, 1,2 14, 1, 12, 1, 8 8, 6 1997_21 1962-1982 6, 4 4, 2, 2
196 1961 1962 1963 1964 1965 1967 1968 1969 197 1971 1972 1974 1975 1976 1977 1978 1979 1981 1982 1983 1984 1985 1986 1988 1989 199 1991 1992 1993 1995 1996 1997 1998 1999 2 22 23 24 25 26 27 29 Micro approach: DJ constituents Pretty impressive coverage in terms of fraction of the entire market cap, ~2% 35% Dow Jones Coverage as % of Total Equity Market Capitalization 3% 25% 2% 15% 1% 5% % DJ Coverage % of Market Cap
19661 19666 196611 19674 19679 19682 19687 196812 19695 19691 1973 1978 19711 19716 197111 19724 19729 19732 19737 197312 19745 19741 19753 19758 19761 19766 197611 19774 19779 19782 19787 197812 19795 19791 1983 1988 19811 19816 198111 19824 19829 Performance of DOW vs total stock market How good was DJ composition reflective of the overall US economy over time? DJIA returned less than the overall market, especially during 1977-1982 period. 14 $1 Buy and Hold DJIA vs Total Equity Market based on real returns incl. dividends (adjusted for inflation) 12 1 8 6 4 2 DJIA with Dividends Total Market Returns incl Dividends
19661 19665 19669 19671 19675 19679 19681 19685 19689 19691 19695 19699 1971 1975 1979 19711 19715 19719 19721 19725 19729 19731 19735 19739 19741 19745 19749 19751 19755 19759 19761 19765 19769 19771 19775 19779 19781 19785 19789 19791 19795 19799 1981 1985 1989 19811 19815 19819 19821 19825 19829 S&P appears to be more reflective of the overall market performance Performance of Dow Jones versus Total Market Index vs SP5, levels (Excluding Dividends reinvestment and inflation adjustment) 1966-1982 1,8 16 1,6 1,4 1,2 1, 8 6 4 2 14 12 1 8 6 4 2 Dow Jones Index Level Total Market Index S&P 5
198211 19834 19839 19842 19847 198412 19855 19851 19863 19868 19871 19876 198711 19884 19889 19892 19897 198912 1995 1991 19913 19918 19921 19926 199211 19934 19939 19942 19947 199412 19955 19951 19963 19968 19971 19976 199711 19984 19989 19992 Much more aligned later due to better representation of key industries of the economy 12, Performance of Dow Jones versus Total Market Index (Excluding Dividends reinvestment) 1982-1999 1,4 1, 1,2 8, 6, 1, 8 6 4, 4 2, 2 Dow Jones Index Level Total Market Index S&P 5
19994 19997 19991 21 24 27 21 211 214 217 211 221 224 227 221 231 234 237 231 241 244 247 241 251 254 257 251 261 264 267 261 271 274 277 271 281 284 287 281 291 294 297 291 Dow as better gauge of overall market performance in the most recent period 16, Performance of Dow Jones versus Total Market Index (Excluding Dividends reinvestment) 1999-29 1,8 14, 1,6 12, 1, 8, 6, 4, 1,4 1,2 1, 8 6 4 2, 2 Dow Jones Index Level Total Market Index S&P 5
Fama and French 12 Industry Classification Industry Name Description 1 NoDur Consumer NonDurables -- Food, Tobacco, Textiles, Apparel, Leather, Toys 2 Durbl Consumer Durables -- Cars, TV's, Furniture, Household Appliances 3 Manuf Manufacturing -- Machinery, Trucks, Planes, Off Furn, Paper, Com Printing 4 Enrgy Oil, Gas, and Coal Extraction and Products 5 Chems Chemicals and Allied Products 6 BusEq Business Equipment -- Computers, Software, and Electronic Equipment 7 Telcm Telephone and Television Transmission 8 Utils Utilities 9 Shops Wholesale, Retail, and Some Services (Laundries, Repair Shops) 1 Hlth Healthcare, Medical Equipment, and Drugs 11 Money Finance 12 Other Other -- Mines, Constr, BldMt, Trans, Hotels, Bus Serv, Entertainment
19661 19666 196611 19674 19679 19682 19687 196812 19695 19691 1973 1978 19711 19716 197111 19724 19729 19732 19737 197312 19745 19741 19753 19758 19761 19766 197611 19774 19779 19782 19787 197812 19795 19791 1983 1988 19811 19816 198111 19824 19829 15.% DJIA Constituents Performance - By Industry 1966-1982 1.% 5.%.% -5.% -1.% -15.% -2.% -25.% NoDur Durbl Manuf Enrgy Chems BusEq Telcm Utils Shops Hlth Money Other
19661 19666 196611 19674 19679 19682 19687 196812 19695 19691 1973 1978 19711 19716 197111 19724 19729 19732 19737 197312 19745 19741 19753 19758 19761 19766 197611 19774 19779 19782 19787 197812 19795 19791 1983 1988 19811 19816 198111 19824 19829 25.% Overall Market Performance - By Industry 1966-1982 2.% 15.% 1.% 5.%.% -5.% -1.% -15.% NoDur Durbl Manuf Enrgy Chems BusEq Telcm Utils Shops Hlth Money Other
BusEq Chems Durbl Enrgy Hlth Manuf Money NoDur Other Shops Telcm Utils Correlation of DJIA Index with Cumulative Industry Returns, by Decade 196 7% 97% 95% 88% 77% 81% 66% 82% 84% 79% 9% 93% 197 5% 62% 66% 19% 53% 55% 44% 55% 39% 74% 24% 27% 198 87% 1% 99% 96% 99% 99% 98% 99% 99% 98% 96% 97% 199 96% 99% 99% 98% 99% 96% 99% 97% 96% 98% 95% 96% 2 41% 62% 68% 63% 85% 87% 81% 68% 89% 77% 44% 74%
3% Correlations and Performance of Dow Jones Returns with Monthly Industry Returns: 1966-1982 25% 2% 15% 1% 5% % BusEq Chems Durbl Enrgy Hlth Manuf Money NoDur Other Shops Telcm Utils Average Annual Correlations Total Cumulative Returns
25% Correlations and Performance of Dow Jones Returns with Monthly Industry Returns: 1999-29 2% 15% 1% 5% % BusEq Chems Durbl Enrgy Hlth Manuf Money NoDur Other Shops Telcm Utils -5% -1% Average Annual Correlations Total Cumulative Returns
Macro look: DOW and Fundamentals How much Dow performance is correlated with the overall economic indicators We looked at CPI (consumer price index) PPI (producer price index) Default spread (difference between Moody s Baa and Aaa-rated portfolios Term spread (measuring slope of the yield curve) Quarterly productivity of the business and manufacturing sectors of the economy Industrial Production index (from the Federal Reserve) Aggregate dividend yield of the market Purchasing Managers Index (PMI) and New Factory Orders from the Institute for Supply Management Seasonally-adjusted Initial and continuing claims Total nonfarm and private payrolls
Correlations with fundamentals 1966-1982, 1982-1999, 1999-29 DJIA S&P5 DJIA S&P 5 DJIA S&P 5 Period jan 1966-Nov 1982 Dec 1982-Mar 1999 Apr 1999-Dec 29 Mean 853.37 95.46 352.5 44.14 1523.15 125.2 STD 95.28 16.66 2247.53 273.35 1429.2 197.21 Nobs 251. 251. 196. 196. 123. 123. DJIA (level) 1..79 1. 1. 1..9 S&P 5 (level).79 1. 1. 1..9 1. CPI (all items).24.71.89.87.3. CPI (less energy).25.71.89.87.23 -.7 Default Spread.16.55 -.7 -.68 -.38 -.5 Term Spread.7 -.1 -.45 -.45 -.5 -.66 Industrial Production.39.74.97.96.78.61 Business Sector Productivity.4.73.91.91.19 -.14 Manufactruting Sector Productivity N/A N/A.97.96.27 -.5 Producer Price Index.22.68.83.8.43.18 Value-weighted Dividend Yield.18.54 -.85 -.84.34.11 Purchasing Managers Index (PMI) from ISM.18 -.16 -.11 -.12.28.3 New Factory Orders.19 -.15 -.13 -.14.14.14 Initial Claims (seasonally adjusted) -.7.31 -.44 -.43 -.48 -.61 Continuing Clams (seasonally adjusted) -.3.28 -.28 -.27 -.48 -.68 Total nonfarm payrolls.35.74.89.88.53.33 Total Private Payrolls.34.75.9.88.59.44 RD/Assets.8.28.92.91.66.47
197 1971 1972 1973 1974 1975 1977 1978 1979 198 1981 1982 1984 1985 1986 1987 1988 1989 1991 1992 1993 1994 1995 1996 1998 1999 2 21 22 23 25 26 27 28 Can proxies for the innovation intensity of the US economy explain DOW performance? RD/Assets ratio and DOW performance seem to comove reasonably well: 93% correlation over the entire period RD/Assets ratio flat during 197-1982, just as Dow is flat around 1, mark Steady increase in R&D is accompanied by a steady increase in Dow Relatively flat Dow performance around 1, is associated with flat (even decreasing R&D during 1999-29 14, 7.% 12, 6.% 1, 5.% 8, 4.% 6, 3.% 4, 2.% 2, 1.%.% DJIA Median RD/Assets
19621 19634 19647 19651 19671 19684 19697 1971 19721 19734 19747 19751 19771 19784 19797 1981 19821 19834 19847 19851 19871 19884 19897 1991 19921 19934 19947 19951 19971 19984 19997 21 221 234 247 251 271 284 297 Industrial Production: leading or lagging? $1 $1 2 $ Industrial Production DJIA (real terms + div)
Composition of US economy has been changing during the period. However, the general pattern, from goods to services was not alter. No change on change. Number of Employees by Industry (Proportion of Total) 1962 1982 1998 28 All Industries 1. 1. 1. 1. Selected Groups Agriculture 3.1% 1.7% 1.%.9% Construction 4.6% 4.2% 4.7% 5.2% Manufacturing 24.7% 18.1% 13.3% 9.4% whole sale trade 4.5% 4.8% 4.2% 4.2% Retail Trade 9.6% 1.9% 11.2% 1.9% Finance, Insurance, Real Estate 3.4% 4.3% 5.8% 5.7% Professional and business services 4.3% 7.5% 11.5% 12.6% Educational Services 1.1% 1.4% 1.7% 2.2% Health Care and Social Assistance 3.2% 7.1% 9.5% 11.1% Arts, entertainment, recreation, accommodation, and food services 4.9% 7.% 8.5% 9.5% Government 2.1% 19.5% 16.9% 17.4% Source: BEA
Price/Earnings Ratios as Predictor of Future 2-year Returns? (Source: Shiller) See 197-1985
Historical P/E Ratios. Would Historical high ratios imply lower returns in the future?
25 Exploration on House Bubble 2 s 2 15 1 5 1962 1967 1972 1977 1982 1987 1992 1997 22 27 Real Home Price Index Real Building Cost Index 14 Proportion of GDP into Construction and Real Estate activities 1998-29 12 1 8 6 4 2 1998 1999 2 21 22 23 24 25 26 27 28 29 Construction Real Estate - Finance