Dow 20,000 and High-Beta ETFs

What does the Dow Jones Industrial Average hitting the 20,000 level mean for ETFs? The short answer is “nothing.” The long answer is a long-winded way of saying pretty much the same thing, but here it goes: It’s just a number, and as every index and index ETF disclosure says, “you can’t buy an index.” Therefore, even if the index value equated to a price, you couldn’t buy the Dow for $20,000.

How is the Dow’s index value determined? Unlike most traditional indexes, such as the S&P 500, the Dow is not capitalization weighted. Instead, it is a price-weighted index, where a stock with a $100 price carries twice as much weight as one priced at $50. Back in 1896, when the Dow first started, the index value was easily computed by simply adding up the prices of each stock in the index, and then dividing the sum by the number of stocks. That, of course, is the mathematical formula for determining an average, and it is how that word came to be included in the index’s name. However, after years of stock splits, dividends, and constituent changes, the divisor had to be adjusted and is no longer simply the number of stocks. Today, the Dow divisor is 0.14602128057775.

You can’t buy the Dow, but you can approximate its performance by buying a single share of each of the 30 components, and that would cost you about $2,920 plus commissions. That should work for a while, but then you will need to determine how to handle dividends, splits, and changes to the companies in the index. However, there is an easier way. You can buy an ETF that tracks the Dow—it’s appropriately called the SPDR Dow Jones Industrial Average ETF (DIA), and it won’t cost you $20,000, or even $2,920. Instead, its current price is just shy of $200 per share, so each share represents about 1% of the Dow’s index value.

The Federal Reserve raised interest rates at the conclusion of its FOMC meeting today, and stocks moved higher after the announcement, pushing the Dow ever closer to 20,000. However, the rally didn’t last long, so we’ll have to wait a little longer to break the barrier. Keep in mind that the 30 stocks in the Dow trade somewhat independently of each other. Collectively, they determine the price of the Dow—not the other way around. Each stock does not know the price of the 29 others, and each is probably oblivious to the Dow divisor. Yet, all these seemingly unrelated things come together in the right mixture to produce the magical value of 20,000.

As suggested above, there is nothing magical about it. However, there is “importance” attached to the number. For the simple fact that it is a big, round number, it gets attention. Most importantly, it gets media attention. Media attention then generates trader and investor attention, and that can create market action. Although the index level of the Dow is somewhat arbitrary in the big picture, there is no denying it has a psychological effect.

The psychology of Dow 20,000 will have dissimilar effects on different people. To some, it will create fear or the desire to sell because it is too high. Others may feel like they missed the boat, prompting them to buy stocks in order to participate in future gains. For traders on the floor of the NYSE, it means a new hat. For me, this milestone will not directly cause me to take action on any of my holdings.

Sectors
Sector rotation out of Health Care continues as it drops to last place and is the only sector with a negative momentum score. Financials remains firmly at the top, and despite the fact it did not assume the helm until a day after the election, the sector has been in a top-three leadership role since early October. Energy solidified its second-place position as crude-oil prices move higher. Industrials and Materials hold down the third and fourth ranking positions, as the smokestack sectors keep control of the market. Telecom and Consumer Discretionary swapped places with Telecom, gaining the advantage. The defensive sectors of Utilities, Real Estate, and Consumer Staples moved from red to green. However, all of the higher-ranked sectors gained ground, too, so it is a sign that the rally is broadening as opposed to the start of a sector rotation. Health Care fell the last two spots to land on the bottom, as biotech and pharmaceutical stocks remain under pressure.

Factors
There has not been any meaningful factor rotation for many months. High Beta, as measured by the PowerShares S&P 500 High Beta ETF (SPHB), has easily been the best-performing factor since mid-February, when it reversed its 18-month trend of weakening relative strength. Value has been aiming to replace Small Size in second place for the past four weeks, and it accomplished that task today. All other factors are in their previous ranking order, indicating no change in relative strength from a week ago. However, each is posting a higher momentum score today, indicating an across-the-board improvement in absolute strength. Low Volatility and Momentum continue to lag the field for a fifth consecutive week, but they did manage to post positive scores today.

Global
Four additional global categories are posting positive momentum scores today, leaving just Latin America and China in the red. North America continues to provide the global leadership, with Canada and the U.S. occupying the top two spots. World Equity holds the third-place spot again, while the remaining developed-market categories fall in line below it. The Eurozone, EAFE, U.K., and Emerging Markets are the four that made the transition to green today. Pacific ex-Japan gained momentum for the week but fell four places lower as other regions made even larger improvements. China fell two spots to land on the bottom, and it is the only global category to lose momentum over the past week.


Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“These numbers can have a huge influence on investor emotion and behavior. When it comes to investing, we’re all just a herd of antelope, skittish and afraid.”

—Brad Klontz, a financial psychologist based in Lihue, Hawaii

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