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Revitalizing the Mix:

The Dow committee is making a relatively rare and significant change to the most famous stock index in the world, the Dow Jones Industrial Average. The companies being removed are energy company ExxonMobil (XOM), pharmaceutical company Pfizer (PFE), and industrials company Raytheon Technologies (RTX). The new additions are biotechnology company Amgen (AMGN), cloud software company Salesforce.com (CRM), and manufacturer Honeywell International (HON).  Changes to the Dow are fairly infrequent as the components have only changed 60 times, averaging just one change every two years.

As a bit of background, the index is currently comprised of 30 of the biggest companies in the United States covering a broad range of industries. The Dow was created by Charles Dow in 1896 and it originally contained twelve industrial companies. The original Dow components were:  American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal and Iron, US Leather, and US Rubber.

In 1916, the Dow index was updated from 12 members to 20 and increased again to 30 in 1928.  Thirty members is where it has remained to this day.

General Electric, the last remaining member of the original twelve, was removed in 2018 and replaced by Walgreens Boots Alliance.  With the removal of ExxonMobil, the oldest member of the index is now gone. Exxon had been a member for over 90 years with its inclusion in the index in 1928 under the name Standard Oil. Proctor and Gamble is now the tenure leader, being a member of the Dow since 1932, when it replaced Nash Motors.

Why the changes and why now? Once Apple Inc. (AAPL) split their stock 4-for-1, there was a ripple affect inside the Dow index. While a stock split technically has no impact on the value of a company, for the Dow, which is a price-weighted index, stock splits do have an impact on the movement of the index. Price weighting means that the stock with the highest price in the index has the most impact on the movement of the index. Apple had become a $500 stock with far greater influence over the movement of the Dow than say a company like Coca-Cola whose stock only trades for around $50.  At $500, Apple’s stock had become 12% of the index and therefore exerted quite a force on the movement of the Dow. On September 1, the 4-for-1 stock split went into effect and Apple’s stock price was no longer the most dominant member, but a mere middle of the pack player (3% of the index).  The stock split served as an automatic profit taking mechanism for the Dow Industrials, by taking its “portfolio” weight in Apple from 12% to 3%. Each of the new entrants will all be in the top 10 in terms of their weightings.

For a market capitalization weighted index (market cap = share price multiplied by the number of shares outstanding) like the S&P 500 Index, a stock split has no impact on a company’s standing within the index. Apple is, at this moment, still the largest weight of the S&P 500. The split does however present tensions between the two behemoths indices, the S&P 500 and the Dow Jones Industrial Average in the index world.

The fall of Apple from first to the middle of the pack also dropped the Dow’s allocation to technology by almost 8%, from about 28% to 20%. Without making any other changes, the Apple stock split would have left the Dow under-allocated to the technology sector in relation to the S&P 500.  However, the addition of Salesforce will bring the technology weighting back up to about 23%.  Because technology has been such a dominant part of index performance lately, being underweight that sector could be detrimental to the index performance. The Dow and the S&P 500 are no longer just measures of market performance and the health of the economy as they were back in the day of Charles Dow. With the advent of index funds and ETFs, they are now money making and asset gathering instruments.  With the Dow otherwise being underweight technology vs the S&P 500 and not owning any of the other FAANG stocks, to remain competitive in the asset gathering space, in addition to keeping a broad swath of industry exposure, bolstering the technology allocation with the addition of Salesforce was imperative.

Employment news:

The good news on the employment front is that the unemployment rate continues to fall, now down to 8.4% from April’s peak of 14.7%.  That said, a continuing area of concern is the still climbing number of permanent job losses.  Historically these two items have moved almost in unison, but today they are moving in opposite directions as the early furloughs are turning into real permanent job losses.   Reversal of this trend will be an important factor to the overall health of the labor market.

To learn more about the Dow Jones Industrial Average click here.

 

General Disclosures: The content contained in this article represents the opinions and viewpoints of Cardan Capital Partners only. It is meant for educational purposes and not meant for consumer trading decisions.  All expressions are as of its publishing date and are subject to change.  There is no assurance that any of the trends mentioned will continue in the future.  Market performance cannot be predicted, so nothing in our commentaries is ever meant to provide any kind of trading advice or guarantee of future results.  Certain information contained herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. Any reproduction or distribution of this presentation, as a whole or in part, or the disclosure of the contents thereof, without the prior consent of Cardan Capital Partners, LLC, is prohibited. Investments in securities entail risk and are not suitable for all investors. This is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.

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