The Dow Jones Industrial Average, one of the main barometers of the US stock market, jumped to all time highs first thing Friday morning. For the first time in its 21 year history, it broke through that 45,250 ceiling! This hike was a result of wildly positive investor optimism, precipitated in part by glowing 1Q earnings filings from many of the largest tech firms. As the day progressed, the index began to back off its large upside. This change exposed just how volatile the market could be as a result of macroeconomic trends instead.
The Dow Jones Industrial Average, created in 1896, is one of the oldest stock market indices in the world. It is made up of 30 of the most heavily traded companies in the United States, which include companies from virtually every industry. It has legacy importance and thus popularity in the investor community. It is criticized for not accurately reflecting the market as a whole because it measures just a few chosen conglomerates.
Record Highs and Subsequent Decline
On Friday morning, the Dow Jones Industrial Average reached an all-time record high, climbing over the 45,250 mark. Unsurprisingly, this all-time high was driven by the release of positive earnings reports from constituent companies. Investors cheered at new commitments by companies that beat earnings forecasts for the last quarter.
As trading advanced into the afternoon hours, the index started to stall out. By IQVIA’s count, analysts saw a positive first day bump. Yet worries over macro economic data points and shifting investor sentiment towards growth stocks led to a retreat. Due to all of these factors, the combined performance of the companies that make up the index has an outsized impact on its movement. With such a small market cap, any one earnings surprise can have a monumental impact on aggregate market sentiment.
This recent volatility is the perfect example of just how fragile the Dow is to outside influences. Indeed, major economic indicators—the inflation rate, the unemployment rate, etc.—arguably rank second only to earnings reports in their potential impact on investor sentiment. When macroeconomic data points to potential economic slowdowns or other uncertainties, investors become spooked. The increased caution is what tends to push stock prices down.
Broader Implications of Earnings Reports
Perhaps the quarterly company earnings reports from the constituent companies are the most influential in determining whether the Dow Jones Industrial Average performs well or poorly. These reports can give stakeholders a glimpse into the factors relating to company profitability and long-term growth potential. Positive earnings surprises can help support investor sentiment, and the reverse can be true for lackluster results.
Investors are eager to spot trends in these reports that may indicate future conditions which will drive their investment decisions. In a big way, that’s because analysts hone in on sectors responsible for the index’s surge. Given the weight of major technology firms, they can still move the overall index a lot. Their positive outcomes do have a lot of weight in the 30-component gauntlet.
Despite being used as a barometer for the overall market performance, critics would say using an arbitrary selection of just 30 companies isn’t the best method. Further, they argue that the Dow is not a good indicator of the overall economy and investor sentiment. Consequently, many investors look at other indices, such as the S&P 500, which encompasses a wider array of companies across various sectors.
Trading Dynamics and Accessibility
Perhaps one of the most surprising features of the Dow Jones Industrial Average is how easily accessible it is with exchange-traded funds (ETFs). These financial products allow investors to trade the index as a single security rather than having to purchase shares in all 30 constituent companies individually. This makes it easier to invest for both individual investors and institutional investors.
With ETFs that track the Dow Jones, you can make a single investment and get exposure to a well-diversified portfolio. This accessibility has made for one of the prime reasons for the index’s use boom – its cross-market attraction. More than any other factor, as interest in ETFs and their overall assets continues to grow, so does their role in driving index trading dynamics.
In addition, trading the Dow as one single entity increases liquidity. This boost in liquidity improves the trading volume. That tension creates a unique ability to make faster changes with short notice as new market information is released or major economic data is released. Depending on the size and order of those movements, they can drastically change the index’s tracking performance over time. This vicious cycle further exacerbates market volatility and creates additional financial instability.