John Hussman: Stocks Removed From Dow Should Outperform

Excerpt from the Hussman Funds' Weekly Market Comment (2/19/08):

... in the equities markets, Dow Jones has decided to alter the composition of the Dow Jones Industrial Average by replacing Honeywell (HON) and Altria (MO) with Bank of America (BAC) and Chevron (CVX). For investors familiar with the contrary record of this sort of substitution, we can take this as a modestly favorable indication for technology and consumer stocks, relative to the prospects for financials and oils. It has been repeatedly and reliably true that stocks kicked out of the Dow and S&P 500 have outperformed the new entrants. Bill Hester wrote a nice research piece on this a few years ago (Misfit Stocks). Recall that in April 2004, International Paper (IP), Eastman Kodak (EK), and AT&T (T) were kicked out of the DJIA, in favor of AIG (AIG), Pfizer (PFE) and Verizon (VZ). While IP and Kodak have generally languished, AT&T has done well enough to pull the rejected group to a slight gain of about 5%. In contrast, AIG and Pfizer have taken major hits, with the three entrants averaging an overall loss of about 25% since their inclusion in the DJIA.

Editor's note: Relevant sector ETFs include the iShares Dow Jones U.S. Consumer Goods Sector Index Fund (IYK), Technology Select Sector SPDR ETF (XLK), iShares Dow Jones U.S. Financial Services Index Fund (IYG), Oil Services HOLDRs (OIH), Vanguard Financials ETF (VFH). See also the full list of sector ETFs.