When General Motors filed for bankruptcy protection this past week, its 83-year tenure as a fixture within the Dow Jones Industrial Average also came to an end. Faced with the abrupt passing of an economic icon, the stock market rallied; a classic case of selling the rumor (fear of the unknown) and buying the news (increased knowledge of the future). This works in the reverse for good news.
Citigroup’s account in the DOW was also closed by Dow Jones. Replacements Cisco Systems (CSCO) and Travelers (TRV) have been given a mixed blessing, however, because over the last decade when stocks are added to the Dow it has generally coincided with a top in the stock’s price.
Meanwhile, a number of Chinese small-caps in our Consensus system have recently caught the fancy of investors, among them China Green Agriculture (CGA), which makes a special type of fertilizer you never heard of, but need to know about. Fluor (FLR) is a beaten down global infrastructure play that garnered more than $5 billion of new orders in the most recent quarter. Lastly, we profile Satyam Computer Services (SAY), a fallen angel we think is worth a gamble.
Detail
One by one, the icons of the economic hegemony of the West are toppling. The collapse of the Twin Towers was a literal tragedy, but also a symbolic event that marked the end of the myth of the invulnerable West. The implosion of the top-tier brokerages in 2008 cracked the financial foundations not only of Wall Street, but also revealed a pervasive Ponzi-like debt structure that has crippled many mainstream institutions.
This past week, the wheels came off the enterprise that for much of the 20th century was the world's largest and most profitable. When General Motors filed for bankruptcy protection on Monday, however, the market rallied on the news. More about that in a minute.
Government Motors
General Motors has been the world’s largest car maker since 1932. As the U.S. government will own 60% of the downsized company and Canada will own 11%, the moniker Government Motors is likely to stick. Clearly the “bankruptcy” is being handled with kid gloves. It is actually part divestiture and restructuring, part nationalization and part bailout, as it will cost taxpayers around $40 billion.
One reason the market was able to rally in the face of the GM bankruptcy (apart from having correctly anticipated it) is that although automotive manufacturing accounts for the majority of manufacturing jobs in the U.S. (4.5 million), manufacturing per se has played a declining role in the U.S. employment picture over the last 30 years. Between 1979 and 2009, U.S. industrial output doubled, but manufacturing labor dropped from 21% of the total to just 9%.
The auto industry is still a key player in the economy, indirectly accounting for perhaps 4 jobs for every position in the industry itself, but in terms of value added, the automotive sector in the U.S. now contributes just 5.5% of total industrial output.
A more important measure of economic health for the U.S. is the Institute for Supply Management’s index of service-related businesses, which make up almost 90% of the economy. The monthly report was issued this week and indicates virtually no improvement in May compared to April. So why is the market rallying in the face of GM’s temporary demise and a dearth of hard data supporting the green shoot hypothesis?
Old News
The simple answer is that the stories that make the headlines are mostly old news to the market. What does the market really pay attention to? The future. In testimony before Congress this week, Fed Chairman Bernanke said he expects “some growth” to return later this year. According to a survey by Bloomberg, most economists agree with the Fed chief and expect the U.S. GDP to expand 0.5% as early as next quarter. This is the “news” the market is trading on. It buys the rumor and sells the facts when the story is positive; it sells the negative rumor and buys the news when the bad news finally arrives. Is this efficient? Perhaps. It is certainly human.
When GM’s bankruptcy was finally confirmed, however, some wheels did turn. Richard Thompson, the editor-in-chief of Dow Jones, quietly announced that GM would be removed from the Dow Jones Industrial Average after 83 years of membership. Only General Electric, which was added in 1907, has been in the venerable index longer.
Curse of the Dow
GM is being replaced in the Dow Jones Industrial average by network hardware maker Cisco (CSCO), not by another auto company such as Ford or Toyota. With respect to the latter company, Mr. Thompson may have missed an opportunity to diversify the index even further by including a foreign-based company that has extensive operations in the U.S. Given that GM is going to be selling its Hummer division to a Chinese car maker, such a move could be viewed as prescient. We certainly expect to see more distressed asset sales to foreign-based companies over the next few years.
But let’s not cry for Toyota. In the last decade, the invitation to join the exclusive Club of Thirty has more often than not marked a significant top in the stock price of the favored company.
Both Microsoft and Intel were plugged into the DJIA in November of 1999 and are now trading far below those levels even after the strongest stock market rally in 75 years. American International Group was added in 2004, never rose much higher and is now 98% below the premium price at which it was added. Pfizer was injected into the DJIA in 2004, which marked a top in Pfizer’s shares. PFE is now 66% lower and bleeding. Bank of America (BAC) became an accredited member in February of 2008, just at the beginning of its historic slide. Shares are now discounted 75%, even after the bounce from the March lows. Kraft Foods was assimilated in September of 2008 and so far that month has marked its peak in price.
But there’s more. In an ironic tortoise and hare tale, Citigroup is also being delisted from the DJIA and will be replaced by Travelers. Citigroup ejected Travelers via a spin off in 2002, as CEO Sandy Weil deemed the stodgy insurance business a leaden liability in his race to conquer the banking world. At first, Weil seemed to have made a savvy choice, as Citigroup shares scampered to a double over the next four years, whereas Travelers’ barely crawled ahead. In the end, however, TRV has a positive net increase today compared to 2002, whereas shares of Citigroup are down 97%. In the end, the spurned tortoise had the last laugh.
Curse of the Dow Jones...
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