GM’s Bankruptcy and Changes to the Dow Jones Stock Market Index

By: Money_and_Markets

Nilus Mattive writes: The bankruptcy of General Motors isn’t surprising … in fact, Martin repeatedly warned Money & Markets readers — for years — that it was coming.

Still, the effects of this bankruptcy will reach all corners of the U.S. economy.

Common stock holders will likely get wiped out.

More than 1,100 dealerships have already received notices that they will have to shut down. Another 1,500 are getting cut in the near future. That will severely impact many already-suffering local economies.

Meanwhile, thousands and thousands of autoworkers are losing their jobs. GM announced nine more plant closures and is idling three more.

Many Americans have had their faith in U.S. manufacturing and ingenuity shaken to the core.

And as perhaps the final symbol of GM’s utter failure, yesterday the company was removed from our nation’s most famous stock market index — the Dow Jones Industrial Average. Citigroup was also jettisoned at the same time.

But Cisco is replacing GM in the index; Travelers will take Citigroup’s place. And therein lies the comfort for me, the immutable principle that all investors would do well to remember …

Change Is Inevitable: Fresh Ideas Create New Industries and Investment Opportunities

A brief history of the Dow proves this.

Way back in 1884, Charles Dow and Edward Jones wanted to create a way to use stock prices to track the overall health of the U.S. economy.

Since Charles Dow and Edward Jones started their index, entire industries have come and gone!

Since railroads were the symbol of the nation’s emerging industrialism, they put together a list of stocks that included nine railroad firms and two other transportation companies. They took the average of the stock prices, and decided to track the resulting number up and down in their “Customer’s Afternoon Letter.” The index became what we now know as the Dow Jones Transportation Average (and the letter became The Wall Street Journal).

Twelve years later, Dow released his Industrial Average, which consisted of 12 important companies that sold cotton oil, sugar, leather, rubber and other products.

Today, the Dow Jones Industrials has grown to a list of 30 companies, and while not all of them are involved in traditional industrial activities, they are all major bellwethers for the U.S. business climate. Each and every company is a name that you know, with products that you’ve very likely used.

Consider Microsoft or Intel, both of which were added to the index back in 1999. Charles Dow could have never imagined the idea of a graphical user interface or a microchip processor.

Now Cisco, another tech titan, is joining the index. And there were other possible Silicon Valley candidates, including Apple or even Google, the youngest of this who’s-who bunch.

There were also other solid non-technology companies as viable candidates ranging from Toyota to Walgreens.

I can’t even begin to fathom what the Dow will look like forty years from now. Some of the names will be the same. But there will certainly be a few that don’t even exist yet. Maybe they’ll be “green” companies. Maybe they’ll produce implantable computers. Nobody knows … and that’s my point!

Innovation won’t stop … trends will come and go … and there will always be money-making opportunities for investors who keep their fingers on the pulse.

Speaking of which, the idea of GM getting replaced in the Dow brings up an important idea that I want you to understand …

Cisco’s shares will certainly benefit from getting added to the Dow Jones Industrial Average!

Stocks Often Pop When They Are Added to Major Indexes!

In and of themselves, indexes are simply lists of stocks that are carefully assembled to represent the general performance of a particular market.

When a company gets added to a prestigious index, it’s a sign that the firm has achieved a certain status in the minds of some important market watchers.

When Cisco and Travelers get added to the Dow, you can be sure they’ll bask in the media afterglow. All that attention can certainly get more investors to hop on the bandwagon, too!

But nowadays, and for an entirely different reason, a whole bunch of people MUST buy a company’s shares when they get added to a major index.

That’s because any mutual fund or exchange-traded fund that tracks the Dow will have to readjust its holdings to track the “new” constituent list.

Let me give you a quick refresher on these index funds. Instead of relying on active management — i.e. individual stock picking — index funds simply attempt to track the broad market’s movements.

While there’s some leeway in exactly how each fund accomplishes this task, most index fund managers will generally buy at least most of the stocks in the index. And in the case of a very short list — such as the Dow — they’ll likely buy them all.

We typically see the biggest “index pops” when changes are made to the S&P 500 index, simply because so much money is tied to it via funds (more than a trillion dollars last time I checked!).

But watch what happens on June 8 when these stocks ultimately join the Dow. I’m willing to bet you’ll see a nice one-day gain in its shares, too.

That should serve as a reminder to us all that there are always solid investment opportunities out there, and even as one former giant falls another company stands ready to take its place … in our economy and our portfolios.

Best wishes,

Nilus

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