In early September it was announced that the Dow Jones
Industrial Average would swap Bank of America (
), Alcoa (
), and Hewlett Packard (
) with Nike (
), Goldman Sachs (
), and Visa (V) under the guise that it was a "desire to diversify
the sector and industry group representation of the index".
Is that really so?
The real reason for the Dow Committee's shift is all about
increasing the Dow's price and they
are already reaping what they sowed because the Dow's
price is lower than it otherwise would be if they didn't change the
Index around last month.
The Dow Committee's bad timing is nothing new though.
The Real Reason for the Dow Changes
The Wall Street Journal recently did a study that puts the Dow
Committee's track record into numbers.
"Since 1929 through 2005, stocks deleted from the Dow gained an
average of 173% over the next 5 years. New additions gained
In our October edition of the
Profit Strategy Newsletter
we took a detailed look at the history of the Dow Committee and
noticed a few more interesting facts:
The committee waited to add tech stocks to the Dow until the
late 90's (Hewlett Packard in '97, along with Microsoft
(NASDAQGS:MSFT) and Intel (NASDAQGS:INTC) not until '99). It
added Pfizer just after the biotech bubble of the early
2000s. It also added financial stocks leading up the
financial crisis. (AIG (AIG) in '04 and Bank of America in early
Not exactly the greatest track record the committee has.
How the Change Affects the Dow
On September 23, the day the switch took effect, the Dow would have
been higher by approximately $2,088 points if it had included Nike,
Goldman Sachs, and Visa since the market lows of March 2009 instead
of Bank of America, Alcoa, and Hewlett Packard.
This means the Dow would be trading at approximately $17,600
today instead of $15,500, but that's only if the Committee would
have added these companies near the bottom. Now they add them
only after an abnormally large rally, five years of age now.
The move will only turn out to be a smart one in hindsight if
the markets continue their rally.
But as we outlined in our October ETF Profit Strategy
Newsletter, no investment decision comes without risk, and the
Dow's committee is risking a continued rise in the Dow price at the
expense of an increase risk in volatility to the index.
We shouldn't believe the commentary of this being about
"diversifying the group" either.
What's the valid reason there are now zero traditional banks
since Bank of America was dropped, but for some reason we now have
two investment banks in JP Morgan (JPM) and Goldman and over 50% of
the credit card industry in Visa and American Express (AXP) in the
Why not Wells Fargo (WFC) which is significantly larger than
Goldman or a handful of other options which make more sense from an
economic impact perspective?
Because, none of the fundamentals of the Dow's makeup matters,
as the real reason for the switch is all about the optics of
getting the Dow's price higher.
The table below is sorted by share price and should show you all
there is to know about the reasons for why the Dow Committee
dropped the three companies they did. Is there any question
as to why the changes were made and also looking at the chart,
which companies will likely be next on their "drop" list?
The Dow (NYSEARCA:UDOW) changes were made strictly due to the
low price points of the three ousted components, but how does this
show the true motives?
The Dow's Quick Math
As a price weighted index, a one percent move on a higher priced
stock such as Visa (1% is around $2.00) affects the Dow's price
much more than a 1% move in Alcoa (1% is around 9 cents). A
1% move higher in Visa raises the Dow 13 points whereas a 1% move
higher in Alcoa raises the Dow less than 2 points.
Put another way, a 1% increase in Visa moves the Dow 8x more
than the same move in Alcoa. Similar ratios exist with the
other 2 additions and subtractions.
The Dow Committee is simply playing games with the Dow to try to
make it go higher by jumping on the market's uptrend. It has
nothing to do with updating the representation or for fundamental
reasons, and as it turns out, the Committee's history shows us they
more often than not make changes at the wrong times.
Ways to Trade It
Those who follow the Dow also now must deal with the consequences
of a benchmark that has much more volatility now. The Dow
point swings work the same way on the way down as they do on the
Since the Dow's change in September, the Dow (NYSEARCA:DIA) was
lower by 67 points three weeks later than it otherwise would be if
it still had its three old components, so already the component
changes are confirming the contrarian signal.
As outlined in the November ETF Profit Strategy Newsletter
published 10/18 not only is the Dow more volatile after the
September shuffle, it also is underperforming the other major
indices setting up a negative divergence. Based on the
history of the Dow changes the odds increase that the Dow will
continue its underperformance.
Profit Strategy Newsletter
uses fundamental, technical, sentiment and common sense analysis to
keep an honest view of the markets. The Dow Committee again
may be sending a key signal not to follow them in their quest to
push the Dow higher through component manipulation instead of
genuine fundamental reasons.
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