Since the advent of equity trading, investors have always tried to look for an edge in the markets, no matter how slight or seemingly spurious. It may surprise some investors to learn that the incomparable Charles Dow — whose innovative market research inspired the creation of the Dow Jones Industrial Average — originated the thesis that forms the backbone of the modern discipline of technical analysis.
The godfather of the markets would undoubtedly be amused that the entrance and particularly the exit of companies from the venerable Dow Jones index would become its own contrarian indicator.
A relatively new phenomenon labeled by some experts of the markets as the “index effect,” it proposes that the stock getting the boot from a major index — such as the Dow Jones — will eventually find greener pastures, many of them sooner rather than later.
Some of the proposed reasons why this distinctive trend occurs are fairly logical. The pressure to perform as a member of the elite 30 companies that comprise the modern Dow Jones index can be overwhelming — and Wall Street isn’t exactly known for its patience.
Without this unwanted attention, management can focus on growing their business. In addition, companies rejected from the Dow Jones carry brand-name recognition but typically at a depressed market value, making them attractive for contrarian investors and discount divers.
We’ll take a look now at three former Dow Jones listed companies who are now stock market ronin.
Once an imposing figure in the personal computer markets, Hewlett-Packard Co. (HPQ) has suffered a major falling from grace. HPQ stock — which briefly traded over $100 per share during the peak of the internet bubble in 2000 — never regained its lofty position in the markets, nor even loosely approached it.
In the five years leading up to its rejection from the Dow Jones in September of 2013, HPQ stock lost roughly 50% of market value, making it “unfit” to represent the esteemed index.
But since getting its pink slip, HPQ stock has jumped nearly 44%. In all fairness, the company has had a difficult time achieving decent numbers, with HPQ stock subject to the slow death throes of the PC industry — a trend that has been going for quite some time. This and other contributing factors led to massive layoffs and further questions of HPQ stock’s viability.
Nevertheless, Hewlett-Packard’s management team remains optimistic, choosing to focus on industries with major upside potential, including “cloud computing, security, software and mobility.”
Technically, however, HPQ stock’s Cinderella run is in some danger. After charging upward for most of 2014, HPQ stock is down 23% year-to-date. Furthermore, its response after suffering consecutive monthly losses in the first quarter of 2015 has been very lethargic. This leaves HPQ stock dangling in no-man’s land and is therefore vulnerable to more pernicious attacks by the bears.
Given the weakness in the PC markets, HPQ stock will need to come up with something big, fast, if it wants to prove the Dow Jones committee wrong.
The famed and respected stalwart in the aluminum production industry, Alcoa Inc. (AA) has fallen into rough times, though hardly of its own doing. The past few years have been extraordinarily difficult for companies in the basic materials sector, and AA stock suffers from some of the same unfavorable fundamentals negatively affecting steel stocks, namely lower international demand and the burden of a strong U.S. dollar.
AA stock was officially removed from the Dow Jones on September 23, 2013, but the writing was on the wall well before then. In the six years prior to its removal, AA stock lost more than 80% of its value, which was a more rapid descent than its industrial competitors. It also contrasted sharply with the fortunes of the Dow Jones, which was up nearly 13% over the same time frame.
But after getting the boot by the Dow Jones, AA stock went on a full-fledged miracle run, moving up 12 consecutive months and doubling its market value. Even with a substantial pullback this year after failing to overcome its 2011 highs, AA stock is still up 34% from the time of its rejection.
Is there another comeback in the making? Perhaps, but it looks unlikely in the nearer-term. AA stock is down 30% year-to-date and the bulls have utterly failed to respond from the bears’ persistent attacks. The only thing that AA stock holders have accomplished was to slow the hemorrhaging by a minor extent. But the sharks are still circling, already smelling blood in the water and no doubt looking to drive AA stock down to its 2013 lows.
AA stock definitely benefitted from the lowered expectations of being a non-Dow Jones company, but now Alcoa faces serious fundamental challenges that will be difficult to overcome.
AT&T Inc. (T)
Since the collapse of global financial markets in September of 2008 until March 2015 when it was booted from the Dow Jones, T stock gained about 69% in market value on an adjusted basis. And in the three years leading up to the rejection, T stock was a model of consistency, with a price range that stayed mostly between 30 to $35.
So why did T stock find itself on the short end of the Dow Jones’ stick? First, the sideways price action of AT&T shares contrasted with the record-breaking run the Dow Jones and the other major indices were — and still are — exhibiting. Second, there were major challenges in AT&T’s business plan, where it faces stiff competition in the mobile carrier markets from smaller rival companies.
Despite getting kicked from the Dow Jones in favor of “it” company Apple Inc. (AAPL), this wouldn’t be the first time T stock received a pink slip from the venerable index. Since first entering the Dow Jones as American Telephone & Telegraph in 1916, T stock “has bounced in and out of the blue chip average over the Dow’s long history,” according to the Chicago Tribune.
If technical trends are any indication, T stock may eventually find itself pulled aback into in the Dow Jones. That’s because, during the sideways period when T stock was in consolidation, the cumulative trading behaviors formed a long-term bullish pennant formation. Coincidentally, when T stock was officially removed from the Dow Jones, this occurred near the apex of the pennant. What we are seeing in the markets now may very well be the early stages of a massive breakout!
If companies with poor fundamentals like Hewlett-Packard or Alcoa can rally immediately after a Dow Jones rejection, how much more can a relatively stable organization like AT&T perform? The answer may be quite surprising … and more importantly, enormously profitable!
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.