Meet The New Dow

9/16/2013


After the market closes on Sept. 20, Alcoa ($8; AA), Bank of America ($15; BAC), and Hewlett-Packard ($22; HPQ) will be dropped from the Dow Jones Industrial Average and replaced with Goldman Sachs ($165; GS), Nike ($67; NKE), and Visa ($185; V). News of the changes raised several questions among followers of the Dow Theory, including:

Why so many changes? S&P Dow Jones Indices, the McGraw-Hill Financial ($62; MHFI) unit that controls the 116-year-old average, says it wants to "diversify the sector and industry group representation of the index." Because of their low share prices, the three departing stocks had less than a 3% weighting in the price-weighted average, contributing to relatively high concentrations in higher-priced names like IBM ($187; IBM).

How will changes be implemented, and won't they confuse things for Dow Theorists? The average's divisor will be adjusted before the market opens on Sept. 23 so the changes don't impact the level of the Dow, just as occurs with a stock split or spin-off. Component changes are a regular part of the Dow's history, and the status of the Dow Theory won't be impacted by the makeover. With closes above the early August all-time highs of 15,658.36 in the Dow Industrials and 6,670.06 in the Dow Transports, the bullish primary trend will be reconfirmed. Still, it would be nice to see confirmation from the S&P 500 Index and advance-decline lines, especially if the Industrials merely eke out a marginal new high.

Do you think the changes bolster the outlook for the Dow? Yes. As shown in the table below, all three of the new Dow stocks have higher Overall Quadrix scores than the departing stocks, reflecting higher scores for Momentum and Quality.

Does the Dow still matter? Yes. The Dow is the oldest and most widely followed index of U.S. stocks, and for all its price-weighted idiosyncrasies it tracks the broader market fairly well. In fact, the Dow and the S&P 500 have a correlation coefficient approaching 90% based on monthly returns, with 100% implying the indexes move in lockstep. Based on rolling 36-month returns, the correlation is about 94%, according to S&P Dow Jones Indices.

DOW STOCKS ON THE MOVE
------------------------------------- Quadrix Scores -------------------------------------
Company (Price; Ticker)
Recent
Or New
% Weight
In Dow

Div.
Yield
(%)

Forecasts
Rating
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
Entering index
Goldman Sachs
($165; GS)
7.0
1.2
A
93
92
54
61
56
51
92
Nike ($67; NKE)
2.9
1.3
B
75
32
88
80
33
65
66
Visa ($185; V)
7.9
0.7
Buy/LT Buy
97
27
99
93
91
43
84
Exiting index
Alcoa ($8; AA)
0.4
1.5
C
34
79
23
24
13
21
32
Bank of America
($15; BAC)
0.7
0.3
B
65
47
18
59
78
83
46
Hewlett-Packard
($22; HPQ)
1.1
2.6
B
49
91
26
27
40
45
54

 

SECTOR EXPOSURES

Sector
Current
Dow
Weighting
(%)
New Dow
Weighting
(%)
Change
In Dow
Weighting
S&P 500
Weighting
Basic Materials
3.3
2.5
(0.8)
3.4
Cons. Discretion.
11.8
12.8
1.0
12.3
Consumer Staples
9.6
8.1
(1.5)
10.2
Energy
10.7
9.0
(1.7)
10.6
Financials
11.4
15.9
4.5
16.5
Health Care
12.1
10.2
(1.9)
13.0
Industrials
22.3
18.8
(3.5)
10.3
Technology
14.7
19.3
4.6
18.1
Telecom
4.1
3.4
(0.7)
2.5
Utilities
0.0
0.0
0.0
3.1

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