Beware: The Dow 30’s Performance is Being Manipulated!

The Dow Jones Indus­tri­al Aver­age (DJIA) Index – the old­est stock exchange in the U.S. and most influ­en­tial in the world – con­sists of 30 com­pa­nies and has an extreme­ly inter­est­ing and dis­tress­ing his­to­ry regard­ing its begin­nings, trans­for­ma­tion and struc­tur­al devel­op­ment which has all the trap­pings of what is com­mon­ly referred to as pyra­mid or Ponzi scheme.

The Dow Index was first pub­lished in 1896 when it con­sist­ed of just 12 con­stituents and was a sim­ple price aver­age index in which the sum total val­ue of the shares of the 12 con­stituents were sim­ply divid­ed by 12. As such those shares with the high­est prices had the great­est influ­ence on the move­ments of the index as a whole. In 1916 the Dow 12 became the Dow 20 with four com­pa­nies being removed from the orig­i­nal twelve and twelve new com­pa­nies being added. In Octo­ber, 1928 the Dow 20 became the Dow 30 but the cal­cu­la­tion of the index was changed to be the sum of the val­ue of the shares of the 30 con­stituents divid­ed by what is known as the Dow Divi­sor.
While the inclu­sion of the Dow Divi­sor may have seemed total­ly straight­for­ward it was – and still is – any­thing but! Why so? Because every time the num­ber of, or spe­cif­ic con­stituent, com­pa­nies change in the index any com­par­i­son of the new index val­ue with the old index val­ue is impos­si­ble to make with any valid­i­ty what­so­ev­er. It is like com­par­ing the taste of a cock­tail of fruits when the num­ber of dif­fer­ent fruits and their dis­tinc­tive flavours – keep chang­ing. Let me explain the afore­men­tioned as it relates to the Dow.

Com­pa­nies Go Through 5 Tran­si­tion Phas­es
On one hand, gen­er­al­ly speak­ing, the com­pa­nies that are removed from the index are in either the sta­bi­liza­tion or degen­er­a­tion tran­si­tion phas­es of which there are five, name­ly:
1. the pre-devel­op­ment phase in which the present sta­tus does not vis­i­bly change.
2. the take-off phase in which the process of change starts because of changes to the sys­tem
3. the accel­er­a­tion phase in which vis­i­ble struc­tur­al changes – social, cul­tur­al, eco­nom­i­cal, eco­log­i­cal, insti­tu­tion­al – influ­ence each oth­er
4. the sta­bi­liza­tion phase in which the speed of soci­o­log­i­cal change slows down and a new dynam­ic is achieved through learn­ing.
5. the degen­er­a­tion phase in which costs rise because of over-capac­i­ty lead­ing to the pro­duc­ing com­pa­ny final­ly with­draw­ing from the mar­ket.

The Dow Index is a Pyra­mid Scheme
On the oth­er hand, com­pa­nies in the take-off or accel­er­a­tion phase are added to the index. This great­ly increas­es the chances that the index will always con­tin­ue to advance rather than decline. In fact, the man­ner in which the Dow index is main­tained actu­al­ly cre­ates a kind of pyra­mid scheme! All goes well as long as com­pa­nies are added that are in their take-off or accel­er­a­tion phase in place of com­pa­nies in their sta­bi­liza­tion or degen­er­a­tion phase.

The False Appre­ci­a­tion of the Dow Explained
On Octo­ber 1^st, 1928, when the Dow was enlarged to 30 con­stituents, the cal­cu­la­tion for­mu­la for the index was changed to take into account the fact that the shares of com­pa­nies in the Index split on occa­sion. It was deter­mined that, to allow the val­ue of the Index to remain con­stant, the sum total of the share val­ues of the 30 con­stituent com­pa­nies would be divid­ed by 16.67 ( called the Dow Divi­sor) as opposed to the pre­vi­ous 30.
On Octo­ber 1^st, 1928 the sum val­ue of the shares of the 30 con­stituents of the Dow 30 was $3,984 which was then divid­ed by 16.67 rather than 30 there­by gen­er­at­ing an index val­ue of 239 (3984 divid­ed by 16.67) instead of 132.8 (3984 divid­ed by 30) rep­re­sent­ing an increase of 80% overnight!! This action had the affect of putting dra­mat­i­cal­ly more impor­tance on the absolute dol­lar changes of those shares with the great­est price changes. But it didn’t stop there!
On Sep­tem­ber, 1929 the Dow divi­sor was adjust­ed yet again. This time it was reduced even fur­ther down to 10.47 as a way of bet­ter account­ing for the change in the dele­tion and addi­tion of con­stituents back in Octo­ber, 1928 which, in effect, increased the Octo­ber 1^st, 1928 index val­ue to 380.5 from the orig­i­nal 132.8 for a paper increase of 186.5%!!! From Sep­tem­ber, 1929 onwards (at least for a while) this ​“adjust­ment” had the affect – and I repeat myself – of putting even that much more impor­tance on the absolute dol­lar changes of those shares with the great­est changes.

How the Dow Divi­sor Con­tributed to the Crash of ​‘29
From the above analyses/​explanation it is evi­dent that the dra­mat­ic ​“adjust­ments” to the Dow Divi­sor (cou­pled with the addition/​deletion of con­stituent com­pa­nies accord­ing to which tran­si­tion phase they were in) were major con­trib­u­tors to the dra­mat­ic increase in the Dow from 1920 until Octo­ber 1929 and the fol­low­ing dra­mat­ic decrease in the Dow 30 from then until 1932 notwith­stand­ing the eco­nom­ic con­di­tions of the time as well.

Expo­nen­tial Rise in the Dow 30 is Revealed
The 1980s and ​‘90s saw a con­tin­u­a­tion of the under­min­ing of the true val­ue of the Dow 30. Yes – you guessed cor­rect­ly –fur­ther ​“adjust­ments” in the Dow Divi­sor kept com­ing and com­ing! As the set of con­stituents of the Dow changed over the years (almost all of them) and many shares were split the Dow Divi­sor kept chang­ing. By 1985 it was only 1.116 and today it is only 0.132129493. Indeed, a rise of $1 in share val­ue of the 30 con­stituents actu­al­ly results in 8.446 more index points than in 1985 (1.116 divid­ed by 0.132129493). Had it not been for this dra­mat­ic decrease in the Dow Divi­sor the Nov.3/10 Dow 30 index val­ue of 12,215 (sum total of the cur­rent prices of the 30 con­stituent shares of $1481.85 divid­ed by 0.132129493) would only be 1327.82 ($1481.85 divid­ed by 1.116) in 1985 terms. Were we still using the orig­i­nal for­mu­la the Dow 30 would actu­al­ly be only 49.395 ($1481.85 divid­ed by 30)!
The cru­cial ques­tions today are:
1. Is the cur­rent under­ly­ing econ­o­my strong enough to keep the Dow 30 at its present lev­el?
2. Will the 30 con­stituents of the Dow remain robust or evolve into the sta­bi­liza­tion and degen­er­a­tion phas­es?
3. Will there be enough new com­pa­nies to act as new ​“up-lifters” of the Dow?
4. When will the Dow Divi­sor change – yet again??

The Dow 30 is the Great­est of All Ponzi Schemes
I call on the finan­cial com­mu­ni­ty to take a crit­i­cal look at the Dow Divi­sor. If it is retained investors will con­tin­ue to be deceived with every new tran­si­tion from one phase to anoth­er and the great­est of all Ponzi schemes will have major finan­cial con­se­quences for every investor.

Wim Grom­men is a guest con­trib­u­tor to http://​www​.Finan​cialAr​ti​cle​Sum​mariesTo​day​.com, ​“A site/​sight for sore eyes and inquis­i­tive minds”, and www​.munKNEE​.com, ​“It’s all about MON­EY” of which Lorimer Wil­son is edi­tor.
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A ver­sion of this arti­cle, enti­tled ​“Beurskrach 1929, mys­terie ontrafeld?”, was first pub­lished in Dutch in the Jan­u­ary 2010 issue of ​“Tech­nis­che en Kwan­ti­tatieve Analyse” mag­a­zine which is a month­ly pub­li­ca­tion of Beleg­gers Belan­gen (Invest­ment Inter­ests) in the Nether­lands and on sev­er­al sites there includ­ing: http://​www​.beur​sprog​noses​.com/​a​n​a​l​y​s​e​/​2​9​2​/​D​o​w​-​J​o​n​e​s​-​I​n​d​e​x​,​-​m​y​t​h​e​-​o​n​t​r​afeld

Wim Grom­men
Voor US Markets