The Dow Is The Real Reflation Trade

By admin_45 in Blog

Even with the recent US equity selloff the Dow Jones Industrial Average is beating the S&P 500 YTD, up 9.7 pct versus 8.2 pct. While it’s not Wall Street’s go-to index for US equity performance and imperfect due to its price-weighted composition, it is still the way most Americans track the domestic stock market. For example:

• There are far more Google searches every day for “Dow Jones” than “S&P 500” or “stock market”. The top queries all apply to stock performance rather than the news organization.
• As a result, the Dow’s performance is the fundamental transmission mechanism for the wealth/confidence effect between equity markets and Main Street/retail investors. That makes it important for both consumer spending and investor confidence.

This makes the Dow worth more attention than it customarily gets, so let’s dig into the Average and see what’s driving its recent outperformance. We calculated the point contribution for the Dow’s 30 components since the end of last year in order to determine its largest winners and laggards over that period. Here’s what we found:

#1: The Dow is quite concentrated, with 10 of the 30 names making up just over half (53 pct) of the index:

• UnitedHealth: 7.9 pct
• Goldman Sachs: 6.9 pct
• Home Depot: 6.4 pct
• Amgen: 4.8 pct
• Microsoft: 4.7 pct
• Caterpillar: 4.6 pct
• McDonalds: 4.5 pct
• Honeywell: 4.4 pct
• Boeing: 4.4 pct
• Visa: 4.3 pct

#2: The Dow is up 2,981 points since 12/31/20, and this came from just over a third of names (data adjusted for rounding):

Big Contributors:

• Goldman Sachs (24 pct of the Dow’s positive points), up 714 points
• Caterpillar (14 pct), up 414 points
• UnitedHealth Group (12 pct), up 364 points
• Home Depot (12 pct), up 363 points

Smaller Contributors:

• JPMorgan Chase (7 pct), up 210 points
• American Express (7 pct), up 222 points
• Chevron (5 pct), up 157 points
• 3M (5 pct), up 152 points
• Amgen (4 pct), up 122 points
• Microsoft (3 pct), up 95 points
• Walgreens (3 pct), up 92 points

#3: Another one third of the names in the Dow are down YTD. The worst 5 in terms of point contributions include:

• Salesforce: down 81 points
• Apple: -68 points
• Walmart: -60 points
• Nike: -59 points
• Merck: -34 points

Here are our takeaways from the data:

#1: Over a third, many industrial/old school names, account for the Dow’s year-to-date positive performance. They are spread across various sectors, but all rallied enough to be meaningful point contributors. That’s because they all continue to reflect confidence in reopening trades and a steepening yield curve. We remain bullish on Energy, Financials and Industrials.

#2: The Dow has decent Tech exposure at 20.5 pct, but that’s still lower than the S&P 500 (25.9 pct) and has dragged on the Average with Salesforce and Apple as two of its worst performers YTD. Even still, the third of Dow names that are in the red YTD only account for a collective loss of 402 points to the index, far less than Goldman Sachs’ 714 positive point contribution YTD.

#3: The Dow has far more industrials (17.3 pct), consumer discretionary (13.5 pct) and financials (15.9 pct) exposure than the S&P (8.9 pct, 12.2 pct and 11.8 pct respectively). Industrials and consumer discretionary benefit from pricing power and large economies of scale, while financials gain from a steepening yield curve.

Bottom line: the Dow’s outperformance versus the S&P 500 reflects how it is better positioned for inflation and higher rates and given the market’s search for names that benefit from inflation this should continue. It also highlights investor confidence in a robust US economic recovery amid improving fundamentals for cyclicals and a positive sign for consumer spending/confidence as it is the main barometer of US equity performance used by most Americans.