The Dow Jones at 125 years old

The Dow Jones Industrial Average celebrated its 125th birthday in May 2021. Created as a simple gauge of stock market performance, this index has survived depressions, bubbles, expansions, 23 U.S. presidencies, two world wars, and two global pandemics.

Initially made up of 12 stocks (versus 30 today), the companies included a leather-maker, a steel provider and a sugar producer – companies that Mr Dow, the creator, decided were crucial contributors to America’s growth.

Out with the old and in with the new

Other than during the period of the Great Depression, the membership of the Dow Jones Industrial Average remained incredibly stable for decades. And, while U.S. Leather, U.S. Rubber and American Cotton Oil eventually went “the way of the buggy whip”, General Electric – one of the original 12 constituents – remained in the index until 2018.

Over the last ten years, however, as the global economy has gone through a technological revolution that has redefined economies around the world, the index has evolved more rapidly than before to better represent changing times.

Out went General Motors, Alcoa, AT&T, GE and Exxon, and in came Apple, Cisco, Visa, and Salesforce.com. Today, health care and technology are the two largest sectors in the Dow Jones “Industrial” Average.

Some of these giant technology stocks have enjoyed stellar performance over the past decade – performance that was given a further boost by the pandemic.

But with valuations of these companies now very high, inflation looking sticker than first assumed, and reopening momentum in full swing, there are question marks over whether these firms can continue to deliver.

Is tech too expensive to invest?

Hugh Grieves, co-manager of Premier Miton US Opportunities, believes smaller, more cyclical companies will do better as the US economy emerges from lockdown. “Usually, when consumers come out of a recession, they are worse off than they were when they went in,” he said. “That’s not the case this time – consumers are better off. And so you’ve got a large number of people with significant savings and a willingness to spend them. They’re going to spend on holidays, they’re going to spend on going out. And that is really going to boost the economy over the next couple of years. And the companies that benefit from that won’t be the tech companies. It’ll be the retailers, it’ll be the restaurants, it’ll be the factories.”

But does this mean that investing in technology is bad idea today? I’d argue not. These firms are making huge amounts of money. Take Google (or more precisely its parent company, Alphabet) for example. It beat the average analyst estimates by an astounding 68% recently, while its net income was up over 160% year-on-year. But it is still trading on a valuation which is almost in line with the market.

To me, this tells investors that despite getting a boost from the pandemic in some areas, these tech beasts were also affected by lockdown, and they too are now recovering. Remember: Apple had to close all its retail stores and Google gets a huge amount of its revenue from travel-related searches. The structural growth for these companies was so strong that we didn’t notice the recovery potential until the recent upswing in earnings.

New long-term drivers of growth

And there is still room for further growth. Jeremy Gleeson, manager of AXA Framlington Global Technology fund, told me recently that he believes we are at an inflection point in terms of growth acceleration in various advanced technologies. Areas like 5G, artificial intelligence and digital banking, for example, offer new opportunities for companies within the technology sector and new opportunities for investors.

More broadly, the semiconductor industry remains critical to the global economy, with this only highlighted by the recent shortage. Current conditions could help manufacturers by supporting their pricing power, but here Jeremy also believes the longer-term opportunity lies in the growth of the market.

The tech giants have undeniably had a good run and many investors will be keen to take profits. But it’s not an area of the market I think investors should divest from completely. The fundamentals remain very attractive for long term investors, and I’d suggest that, rather than limit ourselves to one end of the stock market or the other, perhaps there is room for all types of US stocks in a portfolio today.

Investors wanting a fund that invests in US companies of all shapes and sizes could opt for Lazard US Equity Concentrated. This fund typically holds just 20-30 companies, ranging in size from the fairly small all the way through to the very large.

Alternatively, investors could opt to choose a specialist manager for each part of the American market, for example by investing in the likes of T. Rowe Price US Large Cap Growth Equity, Schroder US Mid Cap and Artemis US Smaller Companies.

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