Arjun Goyal

GE gets Downgraded: The Full Perspective On the Decline of the Former Powerhouse

General Electric just lost its place on the Dow. Is this adjustment more than just an update to the stock index?

By: Arjun Goyal

General Electric just lost its place on the Dow. Is this adjustment more than just an update to the stock index?

Introduction

The Dow Jones Industrial Average recently lost its oldest and only remaining original member: General Electric. In place of the industrial monolith came the Walgreens-Boots Alliance, the second largest pharmacy chain in America (after CVS). While changes in the Dow Jones are not unheard (as you will see below), the dropping of GE seems to be part of a longstanding trend in the American economy and shows how its key drivers continue to shift and adapt as times change.

What does the Dow Jones Industrial Average represent?

Before we dive into historical trends and large scale economic changes, it’s important to understand the Dow Jones Industrial Average’s nuances. The Dow Jones Industrial Average (called the Dow henceforth) is like any other stock index in the world: it measures the prices of a collection of key stocks on the exchange. In the case of the Dow, it picks 30 key stocks that are being traded and amalgamates them into the index. As prices of these stocks move during the trading window of the day, the Dow also moves them.

It is important to note that the Dow is a price-weighted index, meaning that stocks with higher prices have a higher weightage in the Dow (or that their price changes influence the Dow more than others with a lower price). For example, currently the aviation company Boeing has the highest weightage due to its price of $332.93 (as of July 5, 2018). The cumulative effect of the price changes of all 30 stocks determines the change in the value of the Dow. (Note that the magnitude of change is also determined by a constant known as the Dow Divisor, but it is not too pertinent here)

Generally, investors use the movement of the Dow as a signal of the market outlook at the time. For example, the rapid rise of the Dow a few months ago represented optimism in investors’ expectations of general economic performance amongst most companies.

A common question asked at this point is what determines the 30 companies that are included in the index? Well, the actual list of the 30 companies is determined by the editors of the Wall Street Journal. However, they do not have any stringent guidelines or selection process in making this decision. Their goal is to pick large and successful companies who represent significant portions of the American economy. In doing so, they try to make the Dow an indicator of the overall health of the American economy and the confidence of investors in the market.

What’s the deal with General Electric?

The Dow’s announcement to drop General Electric (GE) meant that the index had just lost its only original founding member. As stated previously, General Electric is to be replaced by Walgreens-Boots Alliance (WBA). While there is a sense of unconscious melancholy around the loss of GE from the index, it triggers 2 important questions: why, and so what?

As the Business Times puts it, while GE may have been an industry leader a decade and a half ago, “it foundered in several key industrial markets in recent years”. Moreover, its move from industrial manufacturing (like aviation, automation etc.) and foray into the financial services space meant that the Global Financial Crisis of 2008 hit the company hard. Due to these hard times, GE posts the lowest stock price amongst the 30 companies in the Dow. As you can imply from the previous characteristics of the Dow, this means that it also has the least influence over the value of the Dow out of all the companies.

GE has recently seen itself under new management, with large cost cutting schemes and streamlining strategies to try and renew and boost profitability. However, these efforts have still resulted in scenarios like when CEO John Flannery warned that they may not be able to pay their 2019 dividend.Safe to say, GE is not looking good. Walgreens-Boots Alliance on the other hand seems to a great replacement in the Dow: not only is it more financially stable and profitable than GE at the moment, its stock price is more than 4 times that of GE.

However, the change represents a larger shift. A switch from GE to WBA shows how much more important the pharmaceutical and consumer goods industry is to the American economy when compared to large, blue collar engineering companies. I would go so far as to say that the loss of GE from the Dow signifies the fall of the last bastion in the reign of industrial manufacturing companies being the drivers of the American economy.

Of course, this observation comes in light of the fact that the Dow is meant to depict a representation of companies that have large contributions to the American economy, and those that have  significant ones the American consumer. An analysis of previous changes to the Dow and a look at the current set of companies can show that the economy has gone from being driven by large industrial manufacturing and natural resource companies, to information technology, financial services and pharmaceutical companies.

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Foreshadowing: CNN Money writes about shifting economy and Dow changes in 1999

Historical changes and their implications

The original 12 companies as part of the Dow Jones formed a very different profile when compared to the 30 companies in the Dow today. Looking at the list, more than half of the companies in it are industrial manufacturing companies, like American Cotton Oil, US Leather, and GE. It’s clear that at the time these companies drove the US economy.

As time passed, this list continued to change; most noticeably, the number of companies that were a part of the Dow increased from 12 to 30 in 1928. However, for a large part of the 1920s and 1930s, industrial manufacturing companies continued to be the dominant force in the Dow. This is exactly why the Dow is called the Dow Jones ‘Industrial’ Average. By the end of 1930s, oil and chemical companies had joined the mix, with the likes of Union Carbide and Standard Oil.

This industrial image of the Dow continued till about the late 1980s, when there was the beginning of a shift. Companies like IBM and Coca-Cola had consistently been in the Dow, while industrial companies began to be slowly dropped. Financial services firms like American Express, Citigroup and JP Morgan soon got added. By 1991, the Dow no longer looked purely like an ‘industrial’ stock index. With firms like Boeing, Coca-Cola, AT&T and Walt Disney booming, the list of companies seemed quite diverse. At this point, the Dow shifted radically. Between 1997 and 2005, companies like HP, Microsoft, 3M, Pfizer, Verizon and Intel were added to the index in place of companies like Bethlehem Steel, Texaco and Union Carbide. By 2009, Bank of America and Cisco were there too, in place of automotive heavyweight General Motors. The large aluminum company Alcoa was also removed subsequently, and Apple, Goldman Sachs, Nike and Visa took their places on the stage.

Yes, it may not be too surprising to see these large industrial companies being considered obsolete in place of the younger innovators. It is after all how economies evolve: agriculture to manufacturing to services. But what’s interesting to see is the extent to which this change has taken place. Companies like GE, General Motors, Chrysler and Alcoa are not small companies at all in spite of their mellowed dominance; they still hold immense amounts of economic importance and are organizations which have stood their own in trying times. Yet, barely any of these industrial companies are being considered as part of the 30 to act as an economic signal.

Future Possibilities

All this may not seem too significant; yes, it’s interesting but you may think I’m making a bigger deal of it than it is. But I feel like this moment acts as a sign to us show us what the future of our economy may hold for us. In the same way that industrialists lost their place on the top in a fraction of the time it took them to get there, it’s not implausible to say that there is a high possibility that the firms on the Dow today may be ousted in a similar way.

In fact, I think it may be even sooner, considering how rapid change has become in this age of innovation and technology.

Another observation I have made looking at the way large companies have evolved with respect to each other since the turn of the century is that while this may be the era of technology, a few years ago it was the banks and financial institutions that were considered the drivers of the economy. It was part of the reason why there was such a personnel influx into the financial services industry, and why the system has become so much more complex, with everything ranging from complex credit schemes to exotic derivatives trading. But ever since 2008’s financial catastrophe, when Bear Stearns and Lehman Brothers headlined the tanking of an industry, tech companies have grown to become enormous, with 7 of the top 10 largest companies in the world being technology companies. We are in a time where the tables are turned, and banks are becoming increasingly (if not completely) reliant on technological companies to run their divisions, whether it is high-frequency algorithmic trading, supply chain management, or risk management. Tech companies may not be the main drivers of economic growth in the country yet, but there is no denying that they contribute a large portion towards it and are going to become the key source of future prosperity.

But what’s next? There’s no way to really know. It may be renewable energy companies or something in that area with the way Tesla has made claims (although I’m not so sure how Elon Musk is going to keep to his lofty assertions), or it may be in a completely different space. But what GE’s news should remind us is that the state of economy is in constant flux and there is no saying when and how quickly it can completely change. The misnomer of the Dow’s name is a clear sign of that: the Dow Jones ‘Industrial’, full of tech and pharma.

Works Cited

General Electric loses place in elite Dow Jones Industrial Average. (1400, January 01). Retrieved from https://www.businesstimes.com.sg/companies-markets/general-electric-loses-place-in-elite-dow-jones-industrial-average

Hall, M. (2018, June 07). What does the Dow Jones Industrial Average measure? Retrieved from https://www.investopedia.com/ask/answers/050115/what-does-dow-jones-industrial-average-measure.asp

Historical components of the Dow Jones Industrial Average. (2018, July 21). Retrieved from https://en.wikipedia.org/wiki/Historical_components_of_the_Dow_Jones_Industrial_Average

Keitz, A. (2018, June 20). General Electric Booted From Dow, Replaced by Walgreens. Retrieved from https://www.thestreet.com/markets/general-electric-booted-from-dow-14626922

Kennon, J. Here’s a Guide to Understanding the Dow Jones Industrial Average. Retrieved from https://www.thebalance.com/understanding-the-dow-jones-industrial-average-djia-357912

The Ins and Outs of the Dow Jones Industrial Average. Retrieved from https://www.wsj.com/graphics/djia-components-history/

The Meaning of the Dow Jones Industrial Average. (2014, July 30). Retrieved from https://www.thesimpledollar.com/the-meaning-of-the-dow-jones-industrial-average/

Why Does the Dow Change the Stocks it Tracks?. Retrieved from https://trendshare.org/how-to-invest/why-does-the-dow-change-the-stocks-it-tracks

 

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