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Keeping up with the Dow Jones

Rereading last week’s column made me realise that I may have been responsible for misleading people over the performance of the US stockmarket. My reference to Wall Street moving into new high ground related specifically to the recent recovery in the Dow Jones Industrial Average. This index is almost certainly the most widely quoted in the media when it comes to remarking on how the world’s biggest stockmarket is behaving but is not representative of the market as a whole.

Aside from the fact that only 30 companies make up this benchmark, the way in which it is calculated is inconsistent with modern practice. The DJIA is a share price-weighted index. The greater the price of a stock, the more the influence it exercises on the performance. Contrast that with the way in which most modern indices are calculated – by reference to the overall market capitalisation of the companies included – and you will appreciate that a very misleading picture can emerge.

The index most commonly used by investment professionals as a bellwether for the US market is the S&P 500. This is weighted by market capitalisation, just like our own FTSE indices. The S&P 500 is still around 13 per cent shy of reaching the levels achieved in early 2000. Even so, such is the power of the much smaller and less representative DJIA that breaching the previous peak brought smiles to the faces of traders and investors alike.

Plenty of vehicles track the S&P 500 but few are designed to follow the fortunes of the DJIA. Is questionable whether tracking an index compiled and calculated in such an arbitrary fashion adds any real value.

There is little doubt that investor confidence has been rising, partly reflecting a growing belief that the US is heading for a soft landing. With oil fully a quarter down from the levels attained in the summer, some of the inflationary pressures seem to be easing. The US housing market is looking in less dire straits than feared and hopes are rising that further interest rate increases may not be necessary.

Not that we are out of the woods yet. The Bank of England may have declined to put up rates last week but a number of other central banks have. As well as the European Central Bank edging up the cost of money in the eurozone to 3.25 per cent, countries as far apart as Hungary and Taiwan have been indulging in monetary tightening. That is the other side of a favourable outcome to a US economic slowdown. Inflation may yet enjoy a resurgence, especially as the dampening influence exerted by China could be drawing to a close. The rest of the world will take part as a consequence.

The smart money is on a 25 basis point increase in the UK in November. This does not mean reviving optimism is misplaced, rather that it is too early to be certain of a second leg to the bull market that started more than three years ago. Watching the value in the investments you make remains prudent.

Brian Tora is investment communications director at Gerrard Investment Management


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