The Dow's yearly performance is beating the S&P 500 by the most in decades. Here's why

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The Dow Jones Industrial Average is about to end the year in the red alongside the other two major stock indexes, but here is a silver lining: The 30-stock index is outperforming the S & P 500 by the largest margin in decades. The Dow is the best performer of the three major indexes this year, even though all three are well on pace to end 2022 with losses. On a total-return basis, the Dow is down nearly 8% this year, as of Tuesday’s close. The S & P 500 has shed more than 18% on the same basis, and the Nasdaq Composite is down more than 32% . It’s rare that the Dow would beat out the S & P 500 on a total-return basis at all. The margin by which it beat the larger index — by about 10 percentage points — makes this year’s performance increasingly notable: It’s the widest margin by which the Dow has beaten the S & P 500 since 1958. There are two other instances in which the year-end difference between the two indexes was about as wide – 1980 and 1998 – but the S & P 500 was the leading index in both cases. “Over time, the Dow correlates with the S & P 500,” said Howard Silverblatt, senior index analyst for S & P Dow Jones Indices. “But as you can tell this year, it’s apples and oranges.” Breaking down the Dow Jones Industrial Average The Dow Jones Industrial Average is one of the oldest indexes that investors track. It was first developed in 1896 and started including 30 stocks — which it still does today — in 1928, according to the Library of Congress. The initial stocks were chosen to represent major parts of the U.S. economy. Today, the blue-chip stocks in the index are selected by a committee at S & P Dow Jones Indices who pick them based on performance and to balance the index. That’s different from how stocks are added to the S & P 500 and Nasdaq Composite, which require shares to meet certain parameters such as market capitalization. CNBC Pro’s guide to investing in 2023 2023 should be a brighter year for the traditional 60/40 portfolio Here’s why 2023 could be another solid year for dividend stocks — and how to play it Top Wall Street strategists see a bumpy 2023 ahead with minimal returns for stocks The crypto investing outlook for 2023 after a 60% decline in bitcoin this year Beyond having a much smaller number of companies in the index than the S & P 500 and Nasdaq, the Dow also calculates its weighting differently. The Dow price-weights the stocks in its index, different from the market capitalization weighting used by the S & P and Nasdaq. This price weighting means that stocks with a higher price have a greater impact on the index, even if they have fewer shares. This also affects the sector weightings of the Dow, which means that it has a different breakdown than the S & P 500. Still, the Dow is an often cited index because of its straightforward nature. Many investors can probably name a few companies on the index, and it still represents major parts of the U.S. economy as it did in its inception. “The Dow is a simple thing to understand,” said Silverblatt, adding that this year, simple beat out complex. Of course, its simplicity also means that many strategists don’t see the Dow as a good representation of the current stock market. “It’s very limited in its scope,” said Liz Young, head of investment strategy at SoFi. “And it obviously isn’t a comprehensive representation of the American economy.” Why it outperformed in 2022 The wonky composition of the Dow ended up being one of the reasons it outperformed its more complex index peers in 2022. “The Dow has done better because it was underweighted in those areas that fell the furthest and overweighted in those areas that did better,” said Sam Stovall, chief investment strategist at CFRA. In the Dow, health care, consumer discretionary, financials, communication services and information technology sectors contributed positively to the annual performance. At the same time, sectors that were hit hard, such as technology, are under-represented in the index and thus didn’t weigh it down as much compared to the S & P 500 and Nasdaq. “Those top five names in the S & P 500 had a really rough time of it this year and are really the primary laggards across portfolios,” said Rob Haworth, senior vice president and senior investment strategist at U.S. Bank. “Whereas the more classic industrial names have done much better this year.” What stocks led and lagged the Dow The strongest performers in the Dow – health-care and energy stocks – also helped lift it more than the other indexes, which were in contrast slammed by underperformers such as tech and real estate. The top performers included oil name Chevron , which is up more than 47% this year, and Merck , which has surged more than 43%. The laggards in the Dow didn’t weigh on the index as much as the S & P 500. Tech names Salesforce and Intel shed more than 48% this year, but those were the worst performances on the index. On the flipside, large tech names in the S & P 500 have done much worse. For example, Meta has shed 65% year to date. “A lot of that pain was felt in growth sectors of the market, like tech and communications and consumer discretionary,” said SoFi’s Young. Of course, while the sector weights of the Dow largely boosted its performance, some stocks did push and pull the index more than the S & P 500, Silverblatt noted. For example, a stock such as Apple – which has shed 25% this year – had a very different impact on the two indexes. “Apple took a much smaller component [on the Dow] than the S & P,” said Silverblatt. “The bottom line is that it comes down to the issue makeup and the weightings.” Salesforce, which was added to the Dow in August 2020 to rebalance the index after Apple’s 4-for-1 stock split, also accounted for a much larger portion of the 30-stock index’s loss than it did for the S & P 500. Salesforce has shed nearly 50% this year. Interestingly, it replaced Exxon Mobil in the index, which has surged more than 70% this year – a performance that would’ve boosted the Dow’s total return if it were still included. Even if Exxon were still included in the Dow, it wouldn’t have lifted the index from a negative yearly return, Silverblatt said. What’s to come for stocks To be sure, the outperformance of the Dow is more of an interesting fact signaling the stock market’s year than a piece of investing advice, according to experts. “It’s not something where you would say the Dow is a better index or that the Dow is more resilient,” than others, said Young, adding that she wouldn’t tell investors to own the 30-stock benchmark in this market cycle as the S & P 500 is much broader. In addition, Wall Street analysts say it is unlikely that the Dow will again outperform the S & P 500 in 2023. “I think 2023 will be much more of a stock picker’s market,” said Young, adding that in such a market, looking at the S & P 500 is a better choice because it has so many more options than the Dow. Still, the performance is yet another sign of how 2022 upended what investors had come to expect in the stock market – increasing prices, tech outperforming and a negative correlation between stocks and bonds. “Even if you can’t find relevance in it, it’s significant,” said Silverblatt.