Don't rush to buy Cisco and Travelers on Dow Average Inclusion

Posted by: Aaron Pressman on June 1, 2009

Conventional wisdom says there’s money to be made buying stocks added to a major trading index. This morning comes news that Cisco Systems (CSCO) and Travelers (TRV) will be added to the Dow Jones Industrial Average replacing bankrupt General Motors (GM) and teetering Citigroup (C). So rush out and buy Travelers and Cisco? Not so fast.

The basis of the index-addition effect is the buying power of billions and billions of dollars invested in index funds. But there’s not actually that much money invested in following the Dow, despite its power over headline writers and news anchors everywhere. In fact, a study done by Messod Daniel Beneish of Indiana University’s Department of Accounting and John Gardner of King’s College London found there was no such effect on stocks which entered the Dow, just those added to the S&P 500. Why? Simple — there’s not much money following the Dow relative to the trillion plus invested in the S&P 500. Just compare the exchange-traded funds, for example. The original ETF, the SPDR Trust (SPY), which follows the S&P 500, has $61 billion of assets while the DIAMONDS Trust (DIA), which tracks the DJIA, has just $7 billion.

Also, since the Dow has only 30 component stocks and changes are made relatively infrequently (2008, 2004 and 1999 most recently), there’s a certain — how to put it — “bias” of the index makers involved. In February 2008, they decided to add Bank of America (BAC) and Chevron (CVX). Those were two stocks in two hot industries way back then. Since then? Not so hot. BAC is down about 70% since then versus a 29% drop in the S&P 500. Chevron tailed the S&P 500 for a while but has since caught oil’s upswing so it’s only off 16%.

Now we’re seeing at least one more relatively hot performer added. Cisco is up almost 19% so far this year versus the S&P 500’s 4% gain. And while Travelers is down 6% — poor relative to the index — it’s done a lot better than some of its industry competitors. So be careful out there before you go following yesterday’s conventional wisdom.

Reader Comments

jj

June 2, 2009 1:35 PM

just waiting for the 'whatever' average to go up SO I CAN CASH OUT OF THE PONZI MARKET !!!

JS

June 4, 2009 8:13 PM

This is about your CEO's without college degrees info on Yahoo! Finance. I stop buying your magazine because of biases...but now...I have to stop reading everything you publish. You have placed Maverick Carter on a list with the worlds greats business minds. He is riding the coat tail of LeBron James...he has done 1 major business deal has has no F-ing clue of how to right a damn proposal, business plan or anything...I am shocked and have lost all respect for your magazine...and this lady who wrote this article. How much did Maverick pay for this?

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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