The Dow made some changes yesterday and announced they were adding Goldman Sachs (GS), Visa (V), and Nike (NKE) to the average. Getting the boot were Bank of America (BAC), Alcoa (AA), and Hewlett Packard (HPQ).
Given the Dow is price weighted, the more expensive a stock is, the more it will move the average. It isn’t a coincidence they removed three of the lower priced stocks and replaced them with two stocks over $150. But enough about that, the obvious question is what does this mean?
Well, we did a similar study back in December when the Nasdaq 100-was making changes. The results were being removed was extremely bullish and being added wasn’t. My reasoning was sentiment on something being removed is probably rather extreme, setting the bar extremely low. Any good news could spark a big rally, which is exactly what we’ve seen so far. Here are the returns and they are pretty impressive. NFLX is the big winner, as it is the largest winner in the S&P 500 this year.
I once again pulled in Rocky White, America’s favorite quant and unfortunate Browns fan, and here’s what we found.
Getting to the Dow, we just looked at the stocks that were added. The reason being many of the stocks that were removed don’t exist anymore. Also, Travelers Group (TRV) was added in 1997, but merged with Citigroup (C). It was later spun-off and that is the TRV we know today, but for the purposes of this study we removed it. This left us with 19 stocks that have been added since 1990.
So the stocks are up 15% on average the year before they are added, then up just 3% a year after being added. Not very impressive. At the same time, Bank of America was down 89% a year after being added, so that sure isn’t helping the results. But JP Morgan Chase (JPM) up 91% a year later pretty much offsets it. The median return is a much more respectable 10% jump a year later.
Just to get a more apples-to-apples comparison, we looked at what the Dow did before and after the dates various stocks were added/subtracted. Turns out, the Dow performed rather poorly as well. In fact, it is up just a percent a year later on average after the eight dates of the changes.
This Dow underperformance could be some of the reason the results after being added aren’t that great. Still, in the end I stand by the idea that being added by no means is this big bullish buy signal. In fact, it is probably a sign the bar is set rather high and any poor news could lead to disappointment in the near-term.