Yes, the Dow needs new blood

The people who manage the blue-chip index are substituting Goldman Sachs, Nike and Visa for Alcoa, Bank of America and Hewlett-Packard.

By Charley Blaine Sep 10, 2013 5:34PM
Dow Jones news ticker in Times Square © Paul Taggart/Bloomberg via Getty ImagesIt doesn't happen often that the folks who bring us the Dow Jones Industrial Average ($INDU) bring in three new components.

But there's a reason for the fresh players: They're growing and have less of a chance to be sunk by global forces they can't possibly control.

Those coming in on Sept. 23: investment bank Goldman Sachs (GS), athletic equipment maker Nike (NKE) and transaction company Visa (V).

Saying goodbye to the Dow after Sept. 20 are Alcoa (AA), a Dow component for 54 years; Bank of America (BAC), which has struggled mightily since the 2008 crash; and Hewlett-Packard (HPQ), a tech giant from the 1970s on and inventor of the laser printer.

In the grand scheme of things, the changes won't mean much. They didn't affect departing stocks on Tuesday. Bank of America was up 13 cents to $14.61 as the Dow rallied 128 points to 15,191, its second 100-point gain in a row. Alcoa was off 3 cents to $8.06. H-P slipped 9 cents to $22.27.

The Standard & Poor's 500 Index ($INX) climbed 12 points to 1,683.99, and the Nasdaq Composite Index ($COMPX) added 23 points to 3,729. The rally reflected hopes that tensions over Syria's alleged use of sarin gas were dissipating. Crude oil and gold prices dropped sharply.

Goldman Sachs jumped $5.65 to $165.14. Nike added $1.42 to $66.82. Visa climbed $6.04 to $184.59 -- not bad for a company that went public in early 2008, just before the financial crisis erupted in earnest.

S&P Dow Jones Indexes, which owns the average, along with CME Group (CME) and Newscorp (NWSA), will change its divisor so there's a seamless transition from the Friday close to the Monday open.

Most money managers will continue to use the S&P 500 as the benchmark against which they compare their own performances.

Critics are growling already, as they always do, that the Dow is irrelevant (or just plain ridiculous, as the Washington Post's Neil Irwin wrote today) because it has just 30 components. Fair enough.

But the Dow has been around in one form or another since 1896 and it won't go away. For one thing, it's easier to say "the Dow was up 50 points" than "the S&P 500 was up 8 points."

The Dow is not entirely irrelevant. There are exchange-traded funds built on the Dow and its components.

Plus there's a long and growing literature of studies of the relationship between the Dow and its older sister indexes: the Dow Jones Utility Average ($UTIL) and the Dow Jones Transportation Average ($DJT).

The industrials and the transports have complex relationships. The transports are a leading indicator. If you make stuff, you have to get it to customers. Trucks and trains and jet freighters move it. If the Dow transports start to show sluggishness, that's a signal of softness elsewhere in the economy.

This gets translated into a more abstract theory: Dow theory. Among its six components, perhaps the most important is this: If either the Dow or the transports hit a new high but the other doesn't, that's a negative for stocks. Likewise, it hits a new high and is promptly followed by the other, that's confirmation of an uptrend.

So, why did S&P Dow Jones decide to dump Bank of America, Alcoa and Hewlett-Packard? The ostensible reason is to diversify the index. The more probable reason is this:

Bank of America's share price fell nearly 95% from its peak in 2006 to its bottom in March 2009. It exists because the Federal government rescued it after the crash. Never mind that it is up about 25% this year. It still is down 73% from its 2006 peak.

Alcoa's shares fell 82% between a high of $43 in June 2000 and a bottom on Aug. 30. The company's problem is that it has little control of its destiny. The global market for aluminum ebbs and flows by how much China wants to support its high-cost domestic aluminum manufacturers. When China is in support mode, the global market gets glutted .

Hewlett-Packard's shares fell 85% between April 2000 and November 2012. The company's computer business has been roiled by the rise of tablet devices and smart phones, and H-P's own internal issues. It has had three CEOs since 2005 and regular board turmoil.

So, why the replacement choices?

You could not add Apple (AAPL), Amazon.com (AMZN) or Google (GOOG) because the trio have small numbers of shares outstanding and correspondingly high stock prices. The problem is, the Dow is a price-weighted index. The higher the stock price, the more the stock affects the index. (The S&P 500 and Nasdaq are market weighted: the bigger the market cap, the more effect on the index.)

Apple, in fact, is the world's most valuable company again; taking the title back from Exxon Mobil (XOM) on July 31.

When UnitedHealth Group (UNH) replaced Kraft Foods in 2012, there was speculation Apple would go in. But Apple's stock price was nearing its all-time high of $705.07. To join the Dow would have required Apple to split its stock massively -- at least 5-for-1 -- so its moves wouldn't overwhelm the other Dow components. The company wasn't interested.

So that brings us to the choices.

Goldman Sachs may be controversial for its ruthless self-protection during the 2008 financial crash, but the stock is up more than 120% since the March 2009 bottom. And its business -- investment banking and trading -- is not the same as JPMorgan Chase (JPM) or American Express (AXP). Goldman shares are up about 30% in 2013.

Nike is a manufacturer based in Beaverton, Ore. It is one of those iconic American brands, like Coca-Cola and McDonald's, known around the world. Nike shares are up 29.5% this year.

Visa isn't a bank. Its global network settles credit-card and debit-card transactions. And with MasterCard (MA), Visa is slowly replacing cash. Visa shares are up 22% this year.

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9Comments
Sep 10, 2013 8:33PM
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The Dow "needed" Goldman Sachs? No one thinks that Hank Paulsen didn't quit as it's CEO only to become the Treasury Secretary while Gramm Leach Bliley was active... invented T.A.R.P. and then made GS a "bank" when it had no branches, did no consumer services as has been as un-bank as a non-bank can be... on purpose? Goldman Sachs belongs in the Dow... NOT! It belongs on the bottom of the ocean wearing cement shoes and a lounge singer gown.
Sep 10, 2013 11:13PM
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Dow Jones INDUSTRIAL Average.   Hmmm.  Okay, Nike makes a product, but mostly overseas..  What do Goldman and Visa make?
Sep 10, 2013 10:56PM
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Just have to keep on changing the stocks for the dow so it can keep on going up but in all reality the business economy stinks. It is all about blowing a smoke screen to the investing public. The stocks should stay on the dow until they file for chapter 7 bankruptcy then you will have a true picture of the economy.
Sep 10, 2013 7:15PM
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you beat me to the punch dave - nice post.  financial cheating, buying pro athletes, and encouraging more consumer debt - that's the "new blood" America needs to move forward??

 

this reminds me of all of the frantic last-skyscraper construction, the global hyper-money printing and the return of huge "shadow-banking" loan levels to juice exports in China when their stated goals are to reduce that activity to convert over to domestic spending as their core economic driver.  the crack cocaine of easy money is just too difficult to resist.  these are the last gasps of a failed global financial system that keeps repeating the same over-leveraged, too big to fail, unregulated, easy credit solutions again, and again, and again .....

 

ah well, my mandate is to make money for our clients and we can make almost as much on the way down as we did on the way up ... my heart goes out to the long-term 401(k) buy-and-hold crowd and the future generations of young people who will be left holding the bag on this massive debt repayment and entitlement funding abyss  ...

 

be safe out there ...   

Sep 10, 2013 7:29PM
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Swapping Government Sucks (GS) for Bank of Aholes (BAC) is like getting a transfusion infected with typhoid fever.
Sep 11, 2013 11:09AM
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If they had added Apple instead of Cisco a few years ago the Dow would probably be at 20,000.
Sep 10, 2013 6:31PM
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This is hardly the New Blood that the DOW needs. You have one that's the most Corrupt Money Changer in World History. Then you have the other company that's charges Loan Shark Rates. To top it off, you have a company using slave labor overseas yet still selling way overpriced items to our youth that they are killing themselves over. Maybe this marks the end of the DOW, the last party. Everything ends, eventually.
Sep 11, 2013 11:11AM
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Scott251:Visa and Goldman make billionaires out of millionaires.
Sep 10, 2013 11:13PM
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I have to wonder how "seamless" the exchange will be on the Morning of the 23rd. of Sept.

 

Although a case is made for the changes above, I'm old and am skeptical about major changes;

3 companies instead of one or two..? And I'm not fond of one, GS...

 

General Electric (GE) being I think the only "original left" is subject to World slow downs also..

AT&T (T) was one of the originals or earlys also, but removed a few years back temporarily...

Re-invented itself with migration back to several regional telecoms(rolled up again) and was accepted back on the List....Oh well, we will see.. 

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