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Revamped Dow Set to Widen Gap With S&P 500

August 30, 2020

Even before Apple Inc. unveiled plans for a stock split, the Dow Jones Industrial Average struggled this year to keep up with its broader counterpart, the S&P 500 index.

The addition of three new components on Monday — when Apple starts trading on a split-adjusted basis — likely won’t help matters.

That is because the revamped Dow industrials put less emphasis on technology stocks, the engine behind the stock market’s rebound from the lows of March. Starting Monday, tech will constitute less than a quarter of the Dow’s weight versus nearly 28% for the S&P 500. The broader index includes Inc., Facebook Inc. and Google parent Alphabet Inc. — none of which are in the Dow.

With millions of people still homebound, technology stocks have been clear winners during the coronavirus crisis. People are working from home, streaming movies and using social media to connect with friends and family, hastening the adoption of tech in their everyday lives. Those changes in behavior have made big tech stocks among the few reliable bets during a crisis that has upended most other businesses.

“With the economy we have now because of Covid-19 and the difference between whether companies are open or not, over the short term we could see a significant variance continuing,” said Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.

The S&P 500 is outperforming the Dow industrials by roughly 8 percentage points in 2020 — the widest gap since 1932, according to Dow Jones Market Data. Short-term rifts between the two benchmarks aren’t uncommon, said Mr. Silverblatt, and the Dow and the S&P 500 tend to track each other more closely over longer periods. But this year has been markedly different due to how the pandemic has deepened a split within the market along familiar lines: growth versus value.

Many tech and communications companies in the S&P 500 are growth stocks, or those that promise to deliver faster-than-average profit growth in the future. More staid businesses, such as industrial and financial companies, are often in the value bucket and typically trade at low valuation multiples.

Growth stocks in the S&P 500 have soared 25% this year versus an 11% decline for value shares. The outperformance of growth stocks has driven the market-cap-weighted S&P 500 up 57% from its March 23 trough and 8.6% for the year.

The Dow tilts more toward value by having a bigger representation of industrial, financial and health-care stocks relative to the S&P 500. Its price-weighted structure doesn’t usually help matters, since stocks with the highest share price have the most influence.

The run-up in Apple’s share price this year has benefited both indexes and kept the gap from widening even further. Shares of Apple have traded higher than the 29 other Dow stocks for much of the year, contributing more than 1,400 points to the index. And Apple’s 70% gain since the end of December has pushed its market cap above a record $2 trillion.

Before Apple’s 4-for-1 stock split, tech stocks represented 28% of the Dow, on par with the S&P 500. But some of its other most powerful constituents based on share price — Goldman Sachs Group Inc., Boeing Co. and Caterpillar Inc. — are down in 2020. And the Dow’s most influential stock following the Apple split, UnitedHealth Group Inc., is up just 6.9% this year.

Apple’s split would have put a serious dent in the tech sector’s influence in the Dow. The committee that manages the Dow, which includes editors of The Wall Street Journal, which is published by Dow Jones & Co., a part of News Corp, sought to rectify the imbalance by replacing Exxon Mobil Corp. with Inc., along with two other component swaps. But those changes nudged tech’s weighting up only to 24%.

“I don’t think it means as much as it did in the 1930s,” said Nate Fischer, chief investment strategist at Strategic Wealth Partners.

The disconnect, for however long it might last, isn’t a major concern, said Mr. Silverblatt of S&P Dow Jones Indices. After all, the Dow isn’t meant to imitate the S&P 500 or any other index. Instead, the Dow’s construction is intended to emulate the top of the U.S. stock market, he said.

Take the inclusion of Salesforce. Its addition not only nudged tech’s weighting in the Dow higher, but it also diversified the sector’s representation by adding a pure-play cloud company. When it came time to decide what Salesforce would replace, an energy stock was the obvious choice, Mr. Silverblatt said.

Similar thinking likely played out with the Dow’s other changes. Pfizer Inc. has the lowest share price of the 30 stocks in the index, diminishing the health-care sector’s influence. Its replacement, Amgen Inc., boosts the sector’s heft. Meanwhile, Raytheon Technologies Corp.’s business following the merger with UnitedTechnologies Corp. overlapped with aerospace and defense giant Boeing Co. The substitution of Honeywell International Inc. diversifies the Dow’s industrial stocks.

There are limitations to the Dow. Investors have long questioned why Amazon and Alphabet aren’t included when they represent the 21st century economy. Their hefty share prices would wreak havoc on the index by drastically boosting the weightings of their corresponding sectors. That underscores why $31.5 billion in assets are linked to the Dow through index funds versus more than $11 trillion for the S&P 500.

That hasn’t fazed some investors who have hitched their portfolios to the Dow. Tim Courtney, chief investment officer of Exencial Wealth Advisors, said several clients have sought to follow the Dow by buying shares of a $23 billion exchange-traded fund that tracks the index, the SPDR Dow Jones Industrial Average ETF Trust.

“Some investors think they’re getting better exposure to the broader economy, and you might want to do that if you feel like market weightings in the other two indexes have gone too far,” said Mr. Courtney. “They’re more concerned about valuations so they go to an area not so focused on growth.”–31203977/

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