By: Wim Grommen
It is becoming more and more meaningless to compare the performance of the Dow 30 from one period to another — with the continuing replacement of constituent companies with underperforming and lower priced stocks (losers out), with companies with higher priced stocks with greater future prospects for price appreciation (winners in). We explain below exactly what this reconfiguring (and the further change in the Dow Divisor) encompasses and exactly how it will affect the performance of the Index. Read on, its significance is absolutely dramatic! This manipulation of the performance of the Dow 30 has been going on since 1928 and it was further denigrated this week with a 3 constituent swap which will, in effect, assure that the Dow 30 continues to rise in the long term.
On September 23rd, the Dow got the biggest facelift since 2004 in one fell swoop with the removal of 3 company constituents: Hewlett-Packard Co. (+21.5% ytd), Bank of America, Inc. (+52.0% ytd) and Alcoa, Inc. (-1.8% ytd); and the addition of Goldman Sachs Group, Inc. (+25 ytd), Nike, Inc. (+27% ytd) and Visa, Inc. (+18% ytd), which are expected to have greater future price performance appreciation. (Read: The New Dow Stocks in Three Charts)
What is even more striking is that the three companies removed from the Index have a low share price (HP is trading at an approximate price of $22, BoA at $14 and Alcoa at $8 for a sum total of $44), while the three stocks added have a high market price (Goldman Sachs at $164, Nike at $67 and Visa at $184 for a sum total of $415). Of course there is the Dow Divisor which supposedly ensures that the value of the Dow Jones with the new shares is the same as the value of the Dow Jones with the old shares, but this effect is only short-term as, in the long-term, the profits of the higher priced stocks will be greater/stronger than those of the weaker stocks that they replaced.
The Dow 30 is calculated by dividing the sum of the 30 constituents’ shares by the Dow Divisor. On September 10th, the Dow Jones ended at 15,191 points. The Dow Divisor currently has a value of 0.130216081. This means that the current total of 30 shares is worth $1,978 (15,191 x 0.130216081 = $1,978).
HP is trading at an approximate price of $22, BoA at $14 and Alcoa at $8 (sum total of $44). These shares will be replaced by Goldman Sachs at $164, Nike at $67 and Visa at $184 (sum total of $415), which is 9.4 times more. This means that the new sum of the 30 stocks have a value of $2,349 (1978 – 44 + 415 ) and, therefore, we expect that the Dow Divisor will be adjusted from 0.130216081 to 0.154631 to get back to the original 15,191 Index points (15,191 x 0.154631 = $2,349).
Given the above, had the three old shares increased by 10% each in price in the past, the Dow 30 would have increased by 33.8 points in total (10% x 44 divided by 0.130216081 = 33.79 points), assuming there was no change in the price of the other 27 stocks.
As of September 23rd, however, a corresponding 10% increase in the price of each of the new shares would contribute 268.4 points to the rise of the Dow 30 (10% x 415 divided by 0.154631 = 268.38) or 7.94 times more points.
The influence of the 3 losers was: $44 of $1978 is 2.2% of the Dow Jones Index.
The influence of the 3 winners becomes: $415 of $2349 is 17.67% of the Dow Jones Index.
This stinks of manipulation, double manipulation!
Overview from 2000: winners in, losers out.
September 23, 2013: Hewlett-Packard Co., Bank of America, Inc. and Alcoa, Inc. will be replaced by Goldman Sachs Group, Inc., Nike, Inc. and Visa, Inc.
Alcoa went from a 2007 price of $40 and dropped to $8.08. Hewlett-Packard Co. went from a 2010 price of $50 and dropped to $22.36. Bank of America went from a 2007 price of $50 and dropped to $14.48. Goldman Sachs Group, Inc., Nike, Inc. and Visa, Inc. have risen 25 %, 27 % and 18 % respectively in 2013.
September 20, 2012: UnitedHealth Group, Inc. (UNH) replaces Kraft Foods, Inc.
Kraft Foods, Inc. was split into two companies and was no longer suitable for the Dow. The shares of UnitedHealth Group, Inc. had risen in two years by 53% for inclusion in the Dow.
June 8, 2009: Cisco and Travelers replaced Citigroup and General Motors.
Citigroup and General Motors have received billions of dollars in U.S. government bailouts to survive and were not representative of the Dow.
September 22, 2008: Kraft Foods, Inc. replaced American International Group.
American International Group was replaced after a decision by the government to take a 79.9% stake in the insurance giant. AIG was narrowly saved from destruction by an emergency loan from the Fed.
February 19, 2008: Bank of America Corp. and Chevron Corp. replaced Altria Group, Inc. and Honeywell International.
Altria was split into two companies and was no longer suitable for the Dow.
Honeywell was removed from the Dow because the role of industrial companies in the U.S. stock market in recent years has declined and Honeywell had the smallest sales and profits among the participants in the Dow.
April 8, 2004: Verizon Communications, Inc., American International Group, Inc. and Pfizer, Inc. replace AT&T Corp., Eastman Kodak Co. and International Paper.
AIG shares had increased by more than 387% in the past decade and Pfizer had an increase of more than 675% behind it’s addition. Shares of AT&T and Kodak, on the other hand, had a decrease of more than 40% in the past decade and were removed from the Dow.
The Dow Jones Index is a fata morgana.
In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An Index point is not a fixed unit in time and does not have any historical significance. An Index is calculated on the basis of a set of shares. Every Index has its own formula and the formula gives the number of points of the Index. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.
An Index is calculated on the basis of a set of shares. Every Index has its own formula and the formula results in the number of points of the Index. However, this set of shares changes regularly. For a new period, the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit. In less than 10 years, 12 of the 30 companies, i.e. 40%, were replaced in the Dow Jones. Over a period of 16 years, 20 companies, i.e. 67%, were replaced in the Dow Jones. After such a quick period, the value of a basket of apples in now being compared to the value of a basket of pears.
Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the Index, which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The Index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares, the divider changes continuously. At the moment the divider is 0.130216081, but in 1985 this number was higher than 1. An Index point in two periods of time is therefore calculated in different ways:
Dow 1985 = (x1 + x2 + …….. + x30) / 1
Dow 2013 = (x1 + x2 + …….. + x30) / 0.130216081
In the 1990s, many shares were split. To make sure the result of the calculation remained the same, both the number of shares and the divider changed. An increase in share value of 1 dollar of the set of shares in 2013, resulted in 7.7 times more points than in 1985. The probable cause of the exponential growth of the Dow Jones Index is the fact that in the 1990s many shares were split. At the moment, the Dow is at 15,191 points. If we used the 1985 formula, it would be at 1978 points.
The most remarkable characteristic is of course, the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a takeoff or acceleration phase are added to the set. This greatly increases the chance that the Index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition. From 1980 onward, 7 ICT companies (3M, AT&T, Cisco, HP, IBM, Intel and Microsoft), who were the real engines of the latest revolution, were added to the Dow Jones and 5 financial institutions, which always plays an important role in every transition.
Real truth and fictional truth.
The number of points the Dow Jones is at has created truth or fictional truth.
The number of points says absolutely nothing about the state of a society. You had better look at the number of people in society who use food stamps. That is the real truth.
The first part of this article refers to the article Manipulation of the Dow Jones: This is how it works! (in Dutch) written by Ronald Hendrickx of beurs.com.