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What does Nasdaq invasion mean to the Dow?

Like a trusted old car that's getting a new engine, the Dow Jones Industrial Average becomes a little racier with the inclusion of Microsoft and Intel.

Like a trusted old car that's getting a new engine, the Dow Jones Industrial Average becomes a little racier with the inclusion of Microsoft and Intel.

The two tech companies are part of today's shake-up among the 30 companies that comprise the closely watched Dow. Some industry watchers predict that there may be more volatility in the markets and the index as a result.

"This may make the market more volatile, but these are blue-chip companies," said Peter Coolidge, managing director of equity trading at Brean Murray. "Look at what happened last week to IBM, which is a Dow component and a [New York Stock Exchange]-traded stock--but perhaps going straight down is not considered volatile."

IBM shares plummeted last week when the company warned its future earnings may be hurt by Year 2000 bug concerns.

Despite the recent additions to the Dow, market economists, strategists, and traders say it's unlikely any Internet companies will soon be added to the mix--setting it apart from some of the other indexes that have taken action of late. America Online, for example, was added to the Standard & Poor's 500 last December, making it the first Internet company to capture that honor.

"One of the concerns is that all the indices are going to start resembling each other," said Ned Collins, head trader at Daiwa Securities America. "I think that is something we will some day rue."

Industry watchers say it's just as well that the Dow does not throw more tech issues into its mix; otherwise, the index will begin to take on the characteristics of other indexes and become irrelevant.

The Dow has a long history of serving as a benchmark that people turn to when gauging the performance of the markets and the economy. The index started with an emphasis on industrial firms but has gradually broadened its mix of companies.

Some industry watchers, however, say it has been slow to react to the importance of technology.

"The Dow is yesterday's index, and it's being dragged into the 21st century--and just in time," said Tom McManus, equity portfolio strategist for Banc of America Securities.

Coolidge noted, however, that the Dow "is a benchmark that has been used and is continuing to be used to measure the market, and whether it is the most relevant index is beside the point."

Industry watchers also note that despite the Dow's revered status as a market benchmark, it is the S&P 500 that institutional investors turn to when taking the market's pulse, and instead, they use the Dow as more of a thermometer on the economy.

Although the Dow is the most strongly associated with the market, more and more people are referring to the S&P, because it is much more representative, Collins said. "With [the Dow] you really are just talking about 30 stocks out of a universe of more than 10,000 issues." Industry watchers also note that the general public uses the Dow as a reference point. Institutional investors rely on the much broader S&P 500 and consider the Dow to be more of a barometer of the economy.

Validating the Nasdaq
The addition of Intel and Microsoft is something of a coup for the Nasdaq Stock Market. Adding the two relatively young companies--Intel was founded in 1968 and Microsoft in 1975--marks the first time Nasdaq-listed stocks have been promoted to the Dow.

"We're pleased by the decision to include Microsoft and Intel in the Dow Jones Average, as it reflects the importance of these two companies in the new economy," Frank Zarb, chief executive of the National Association of Securities Dealers (NASD), said in a prepared statement.

"Microsoft and Intel now will be part of the Nasdaq-100 as well as the Dow Jones Industrial Average, and that's a very special position. The companies that are being replaced are fine companies, but Dow Jones has carefully weighed all the factors involved and arrived at their decision. The inclusion of these two Nasdaq companies makes the Dow more reflective of today's global economy."

Microsoft and Intel are expected to get a share price boost from the inclusion in the Dow, as investors who track indexes buy those stocks for their portfolios, McManus said.

Other tech stocks, however, are not expected to get a share price ride on the coattails of Microsoft and Intel, McManus added.

He noted: "The price action on these stocks was an overreaction and more psychological. There is not that much money that is being indexed to the Dow."

Few Internet companies are expected to be included in the Dow anytime soon. "The Dow is a special index, and it's worried that the companies display a certain maturity before they're included," McManus said.

Edward Yardeni, chief economist and global investment strategist with Deutsche Banc Alex Brown, noted that as technology becomes a larger part of the U.S. economy, the Dow will need to increase the number of companies that represent that sector.

"The Dow is supposed to reflect the top 30 industries that reflect our economy," he said. "Technology today accounts for 10 to 15 percent of the [gross national product]."

Yardeni added that although technology represents up to 15 percent of the economy, the industry accounts for 25 percent of the companies included in the S&P 500.

"The market is anticipating technology will become a bigger factor in the economy than it is today," Yardeni said. "And the markets move ahead of the economy in anticipating growth...I think in another five years, technology could account for 25 percent of our economy."