The S&P 500 is blowing past the Dow by double digits - here's why that will change

By Mark Hulbert

Nvidia and Meta Platforms are two reasons for the S&P 500's outperformance

At the top of the internet bubble in early 2000, the S&P 500 SPX was outperforming the Dow Jones Industrial Average DJIA by even more than it is nowadays. That should give pause to those who wonder if there's something wrong with the Dow that causes it to be such a laggard. You could just as easily argue that the fault lies with an inflated S&P 500.

The Dow over the past six months has lagged the S&P 500 by about 12 percentage points. The average trailing six-month spread over the past 10 years is just nine-tenths of a percentage point. This oscillating market leadership between the Dow and the S&P 500 implies that at some point in the coming months and years, the Dow will be ahead of the S&P 500 by as much as it currently is behind.

The record for a six-month spread occurred on March 8, 2000, when the S&P 500 was 13.7 percentage points ahead of the Dow. The Nasdaq Composite COMP hit its internet-bubble high two days later. We all know what happened next.

Fortunately, that experience was an outlier. To show this, I measured the correlation between the S&P 500-vs.-Dow trailing six-month spread and the stock market's subsequent six-month performance. The correlation was not significantly different from zero, which means that we can draw no conclusion from the current spread about how the overall market is likely to perform in the coming months.

Almost all of the top-10 S&P 500 stocks have inflated P/E, price/book and price/sales ratios, and depressed dividend yields.

Value vs. growth

We can draw a conclusion about the likely relative performance in coming months of value and growth stocks, however. That's because the S&P 500 is closer to the growth end of the growth-vs.-value spectrum than the Dow is. Since historically market leadership has oscillated between the two stock styles, a large S&P 500 lead is often followed by just the opposite.

The table above illustrates how close the S&P 500 is to the growth end of the spectrum. It lists the valuation ratios of the 10 largest stocks in that index. Notice that almost all of them have inflated P/E, price/book and price/sales ratios, and depressed dividend yields. Notice also from the table that only four of these 10 largest S&P 500 stocks are in the Dow.

Since many of those largest stocks are in the so-called Magnificent Seven group that has produced the lion's share of the stock market's year-to-date performance, it's easy to understand why there's been such a large spread between the S&P 500 and the Dow.

The oscillation between growth and value was definitely seen in the wake of the internet-bubble burst in 2000. By April 2001, just over a year after the top of the bubble, the Dow was almost 16 percentage points ahead of the S&P 500 in trailing-six-month return. That's an extraordinary swing of about 30 percentage points in relative six-month returns, as the chart below shows.

Price weighting

Still, the Dow is not a perfect benchmark for stock-market performance by any means. On the contrary, there are serious objections to it. The point here is that lagging the S&P 500 is not by itself one of those legitimate objections.

Perhaps the most serious objection to the Dow is that its stock-price methodology is an irrational basis for determining each component stock's weighting. For example, the highest-priced stock of the Dow currently is UnitedHealth Group Inc. (UNH), so it has the greatest weight of any of those 30 stocks. The lowest-priced DJIA stock currently - Intel (INTC) - has a price that is one-fifteenth of UnitedHealth's stock price, so Intel's weight in the Dow is one-fifteenth that of UnitedHealth's.

There is no theoretical basis for giving UnitedHealth 15 times the weight of Intel because its price is 15 times as large. Imagine what would happen if UnitedHealth split its shares 2-for-1: Its weight in the Dow would immediately be halved, even though, in reality, nothing would have changed.

When the Dow was created in the late 1890s, price weighting was chosen not for theoretical reasons but for ease of calculation: The Dow's value was simply the sum of the prices of the component stocks. The S&P 500, established in the late 1950s, is a capitalization-weighted index.

Nevertheless, too much should not be made of the Dow's defective weighting algorithm. Despite the significant differences between the Dow and the S&P 500, their long-term total returns are remarkably similar. Over the past 25 years, for example, the SPDR Dow Jones Industrial Average ETF DIA, which is benchmarked to the Dow, has gained an annualized 7.6%. Over the same period, the annualized total return of the SPDR S&P 500 ETF SPY has been 7.7%.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

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06-29-24 1232ET

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