Wednesday, September 18, 2013

A shake-up for the Dow

The Dow Jones Industrial Average is getting another makeover this week.  On Sept. 20, the Dow 30 stock industrial index will replace three of its older components – Alcoa, Bank of America, and Hewlett Packard – and will replace them with Goldman Sachs, Visa, and Nike.  This makes the 52nd time since its inception in 1885 that the index has changed components. 

The change was prompted by the underperforming stock prices of the outgoing components, according to a spokesman for S&P Dow Jones Indices.  The index committee also cited a desire to diversify as a reason for the change.  According to Bloomberg’s Nick Taborek, it’s the Dow’s “biggest reshuffling since April 2004.”  The Dow’s proportions are determined by the dollar value of its constituent stocks, and the addition of the three high-priced stocks will reduce the relative weight of other stocks in the index, significantly boosting the share of financial firms in the index.  Visa will carry 7.7% of the Dow’s value while Goldman will have 6.9%.  Visa and Goldman will also become the second- and third-most important stocks in the index, according to Bloomberg.  

Timing is always an issue whenever the Dow 30 index is recast.  In seven of the eight previous instances since 1999 when the Dow’s components were changed the index was lower within a month.  The only exception to this was in Nov. 1, 1999 when the Dow’s components were changed and the Dow was higher for the next two-and-a-half months before peaking.  In the last 10 years the Dow has always slumped – in varying degrees – in the weeks following realignment.  

Could the latest Dow 30 shuffle result in yet another short-term top?  Considering the month of September often witnesses a top, and considering that two of the high-profile Dow replacement stocks are hefty financial firms (at a time when pundits are cheering the resurgence of the financial sector), the contrarian play would seem to favor an October pullback for the indices.