Article Flashback: April 20, 2009

Below is my response to a critic of my April 20, 2009 article about how past management of the Dow Jones Industrial constituents had contributed significantly to the declines in the market from 1929 to 1932. I feel that this response is so instructive about stock indexes and the crash of 1929 that all my new readers should see it again for the first time.

According to this critic (SivBum) the purpose of an index is, "not to pick stocks with strength but to reflect the overall market place."

My response was the following:

"I completely agree with your comment that the purpose of the index isn't to pick stocks with strength but to reflect the overall market. However, you need strong companies to last long enough to actually reflect the market. Otherwise, the companies chosen would go out of business and then have to be be replaced. As you'll see below, many other stocks that went in and out of the index never were either obsolescent or bankrupt.

Although AIG has been nationalized it conceivably could still be in the index. After all, even though the railroads were nationalized in 1914 they still were part of the Dow-Jones Transportation Index.

Regarding changes to the Dow it should be noted that many companies have been added and dropped in the fashion of an inexperienced trader. Here are some notable examples:

• American Tobacco was dropped in 1899 and added in 1924, was dropped in 1928 and replace with the American Tobacco B shares, B shares were dropped in 1930
• General Electric was dropped in 1898, added in 1899, dropped in 1901, added 1907.
• IBM was added in 1932, dropped in 1939, added in 1979
• International Paper preferred shares were added in April 1901, dropped July 1901, common shares were added in 1956, dropped in 2004.
• Remington Typewriter was added in 1925, dropped in 1927
• Texaco or Texas Company was added in 1916, dropped in 1924, added in 1925, dropped in 1997.
• Goodrich was added 1916, dropped in 1924, added in 1928, dropped in 1930.
• Coca Cola was added in 1932, dropped in 1935, added in 1987.

The evidence seems to indicate that the managers of indices act like traders rather than trying to reflect the overall economy or market."

I have to thank the critics on Seeking Alpha for forcing me to go the extra mile in my research to make an even better point than I had set out to. Touc.