In early September it was announced that the
Dow Jones Industrial Average
(INDEXDJX:.DJI) would swap
Bank of America
(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
Wall Street Journal
recently did a study that puts the Dow Committee's track record
"Since 1929 through 2005, stocks deleted from the Dow gained an
average of 173% over the next five years. New additions gained
In our October, 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
'90s (Hewlett-Packard in '97, along with
(NASDAQGS:INTC) not until '99). It added
(PFE) just after the biotech bubble of the early 2000s. It also
added financial stocks leading up the financial crisis. (
(AIG) in '04 and Bank of America in early '08).
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 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
(JPM) and Goldman and over 50% of the credit card industry in Visa
(AXP) in the Dow?
(WFC) which is significantly larger than Goldman or a handful of
other options which make more sense from an economic impact
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 changes were made strictly due to the low price points of
the three ousted components, but how does this show the true
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 $0.09). A 1% move
higher in Visa raises the Dow 13 points whereas a 1% move higher in
Alcoa raises the Dow less than two 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 two
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 way up.
Since the Dow's change in September, the
(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.
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.
Editor's note: This story by Chad Karnes originally appeared on
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