Did GM Really Bring Down the Dow?

The headlines were screaming: Dow closes in the red Friday after GM's late-day skid. Perhaps a more appropriate headline should have read: A 25% decline in GM barely budges DOW. (After all, Dow was only down 0.18% Friday). The massive 25% decline in GM stock contributed only about 0.04% to Dow’s decline (or about 25% of the day’s decline). So much for the adage, "as GM goes, so goes America".

The Dow is a price weighted index, so as the price of a stock goes to zero, the impact on the index becomes increasingly insignificant. The upshot is that GM’s contribution to Dow is basically non existent. If GM were to file for bankruptcy, and GM stock goes to 0, (or $0.01 as detailed in this SEC filing), Dow would only be down by 0.1% because of it. That’s noise basically.

Just for fun, I decided to calculate the Dow Jones index with various components removed:

click to enlarge


As can be seen, the impact of removing General Motors and Citigroup (C) from the Dow is only 0.5%. (Looks like Mr. Market has basically priced in a GM bankruptcy and Citi common equity getting diluted to oblivion.) Further, Bank of America (BAC) or General Electric (GE) going to zero would only result in declines of 1.06% and 1.26% respectively. Even including all four, we're looking at a 2.8% decline. So basically, all these components becoming pretty much worthless is already priced in. What's NOT priced in however, is these components going back to their earlier price highs.

Wintel's effect on Dow: Just for fun, and for the sake of illustrating the weirdness caused by using price weighted indexes, I've included the impact on the Dow of removing Intel (INTC) and Microsoft (MSFT). As can be seen from the chart, both Intel and Microsoft can go out of business, and the Dow would only suffer a 3.3% decline.

Role of financials in Dow: Let’s assume that things become great and the financials go back to their pre-crash market capitalization. Even then, because of the record high equity dilution in the financials (because of TARP injections, preferred to common conversion, raising capital in the form of equity, etc) their stock prices would remain low (unless they do a reverse split). Because Dow is price weighted, what that basically implies is that the financials would have an increasingly small role to play in Dow’s daily gyrations, even assuming they go back to their previous market capitalization highs.

Financials under performing in the next bull market is almost a certainty as far as the Dow is concerned.

The data above basically shows how concentrated the Dow index really is. For all practical purposes, Dow was a 26-27 component index Friday.

Full Disclosure: Short GM calls.

Comments

[PastTense:]

And the followup question (considering the oddball weighting of its components) is why anyone pays any attention to the Dow at all?

May 24 11:56 AM

[Graybeard44:]

An even better question would be: Why does anyone pay attention to the market "gurus" who come up with this stuff?

May 24 07:44 PM

[babyray:]

You mean the market "Gurus" who didnt see the economy falling apart.

May 25 09:06 PM

[psilocybe_m...:]

are you kidding me? oh it had nothing to do with the losses of the financial giants.... which had nothing to do with forclosures ... with job losses. this blame game where gm isn't good enough this and that is just nonsense. the people running the dismantling of gm are the same internationalist that have been destroying the working class and the young in this country. bankruptcy's just another word for "no job for you." post-industrial america you are just getting started....what are you gonna do with all the people under 35? put them ALL in prisons???? the answers are scarier than we want to admit.

May 26 06:15 AM

[User 313082:]

I will eat my hat if the bankrupcy of GM does not cause the dow to fall more than 0.1%. If you want to correlate something try correlating volatilty with consumer confidence & consumer confidence before and after GM falls. Markets are not based solely on any one logic, but fear grows when companies fold. When jobs decrease, people start thinking more conservatively. Alot of people who believed that GM should be supported by bailouts will start to question their other positions supporing other companies claiming sustainability. Following GM falling, volatiltiy will increase, consumer confidence will decrease and the market will continue trending downward. IMO.

May 26 09:34 AM

[jimkim:]

Start chewing Bubba.

Jun 01 07:08 PM