GM Leaving the Dow (Soon): Likely Replacements

by: IndexUniverse

By Matthew Hougan

General Motors' (NYSE:GM) bankruptcy is all but a sure thing, and with it, the company's 81-year run as a component of the Dow Jones Industrial Average will come to a merciful end.

According to Reuters, sources say that GM will likely file for bankruptcy some time after midnight tonight and before June 1. The company has apparently failed to convince bondholders to exchange their debt for an equity stake in a restructured company, ensuring the bankruptcy filing.

(In an interesting quirk, the AP reports that many bondholders hold credit default swaps on their GM debt. If the company files for bankruptcy, these CDS swaps will be triggered. The Depository Trust & Clearing Corp. says these CDS swaps will pay out $2.33 billion if the company enters bankruptcy. Talk about perverse incentives.)

As always, I can't help but to speculate about which company will be chosen to replace GM when it exits the Dow.

I wrote a similar blog back in September 2008, when American International Group (NYSE:AIG) was removed from the benchmark. At the time, my thoughts focused on two companies: the banking giant Wells Fargo (NYSE:WFC) and the biotech megalith Amgen (NASDAQ:AMGN).

Both healthcare and finance were under-represented in the DJIA vis-a-vis the S&P 500 and I figured the index committee would look toward those sectors for replacement to round out the index.

As we all know, I was wrong. Dow picked Kraft Foods (KFT), adding the first food component to the index. It said it did not replace AIG with another financial company due to "extremely unsettled conditions" in the financial market.

Fast-forward to today: Have things settled down enough now to make adding a financial company an OK bet?

I'm of mixed minds. Things have certainly settled down since September 2008, when it was not clear there would be a financial sector going forward, and companies faced a day-to-day battle to survive. But it's not as if the financial industry is completely out of the woods.

So what do I think will happen? If I were a betting man, I'd say that the good folks at Dow Jones do a bit of a clean-up of the index, replacing not just GM but Citigroup (NYSE:C), too. If that happens, the smart money says that Wells Fargo will enter the index as a new financial representative, with Goldman Sachs (NYSE:GS) a distant second bet.

Beyond that, it's an open race. I still think Amgen would be an interesting choice, but Nike (NYSE:NKE), Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG) and a few others probably make the short list as well.

A Note For Jim Wiandt

Before you jump on your holier-than-thou indexing horse when writing about my reflation portfolio, it might pay to actually read my blog first.

You write of my list of ETFs designed for a reflationary environment: "Laying out a portfolio that adds up to 100% and filling it with mostly alternatives that should probably add up to 5 or 10% maximum of someone's portfolio seems like dangerous advice."

Good point.

That's why I wrote: "I don't think this should be 100% (or even 50% or 25%) of someone's portfolio. I don't own all these funds myself; my portfolio, as most people know, is boring, long-term focused and ultra-low-cost."

It's funny how I make all the most important points a day or two before you do.