The present crisis, a pattern?

Dow Jones Industrial Average

Figure 2: Exchange rates of Dow Jones during the latest two industrial revolutions. During the last few years the rate increases have accelerated enormously.

Industrial revolutions and stock market indices

The Dow Jones Industrial Average was first published halfway through the second Industrial Revolution, in 1896. The Dow Jones Industrial Average (DJIA) Index is the oldest stock index in the United States. This was a straight average of the rates of twelve shares. A select group of journalists from The Wall Street Journal decide which companies are part of the most influential index in the world market. Unlike most other indices the Dow is a price-weighted index. This means that stocks with high absolute share price have a significant impact on the movement of the index.

The S & P Index is a market capitalization weighted index. The 500 largest U.S. companies as measured by their market capitalization are included in this index, which is compiled by the credit rating agency Standard & Poor's.

The BEL 20 is Belgium's most important stock market index. It consists of up to 20 stocks chosen by the market authorities of Euronext, based on a number of criteria. First and foremost, they need to possess a sufficiently high market capitalization. Then the stocks are ranked according to their free float market capitalization. Then, besides the market capitalization other criteria such as the liquidity and marketability are taken into account, to fill the remaining four places. From a weighted average of the prices of these shares, the position of the BEL 20 is calculated.

What does a stock exchange index like DJIA, S&P 500 or BEL 20 really mean?

In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance.

An index is calculated on the basis of a set of shares. Every index has its own formula and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.

· An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit.
After a period of 25 years the value of the original set of apples is compared to the value of a set of pears. At the moment only 6 of the original 30 companies that made up the set of shares of the Dow Jones at the start of the acceleration of the last revolution (in 1979) are still present.

· Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.132319125 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:
Dow1985 = (x1 + x2 + ........+x30) / 1