Beware: The Dow 30’s Performance is Being Manipulated!
Guest
post by Wim Grommen. Mr. Grommen was a teacher in mathematics and
physics for eight years at secondary schools. The last twenty years
he trained programmers in Oracle-software. He worked almost five
years as trainer for Oracle and the last 18 years as trainer for
Transfer Solutions in the Netherlands.
The
last 15 years he studied transitions, social transformation
processes, the S-curve and transitions in relation to market indices.
Articles about these topics have been published in various magazines
/ sites in The Netherlands and Belgium.
The
paper “The present crisis, a pattern: current problems associated
with the end of the third industrial revolution” was accepted for
an International Symposium in Valencia: The Economic Crisis: Time for
a paradigm shift, Towards a systems approach.
On
January 25 2013, during the symposium in Valencia he presented his
paper to scientists.
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 greatlyincreases
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 1st, 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 1st, 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 1st, 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 societies 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.
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: Beurskrach
1929 mysterie ontrafeld? op Historiek.net (English
version Stock
Market Crash 1929, Mystery Unraveled?
Wim
Grommen is
a guest contributor to http://www.FinancialArticleSummariesToday.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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