DOW JONES INDUSTRIAL AVERAGE REPLACES GM AND CITI WITH CISCO AND TRAVELERS-AVERAGE WOULD BE 300 POINTS HIGHER IF THEY WERE IN IT EARLIER

The announcement that two of the long time DOW components (GM and CITI) were going to be substituted, did not get a lot of press, but that substitution could have major implications for the calculation of the DOW AVERAGE that is so widely publicized.

Some financial analysts did a "what of" analysis to test to see if the two new member components of the DOW; CISCO AND TRAVELERS.

They discovered, that this type of substitution would have had a major effect on the DOW AVERAGE figure that is reported daily. They estimated that if those two stocks were in the DOW for the last 12 months, the DOW would be approximately 300 POINTS HIGHER than reported!

So imagine what that would be like? Is it a run away market, is it a new bull market rally?

The DOW is watched so much and reported daily on all the financial newscasts, yet it could be significantly erroneous or not based on who the components are. So by substituting the stocks, and many other throughout its long history, the distortions could have major implications.

General Motors Corp. and Citigroup Inc., crippled by the first global recession since World War II, were removed from the Dow Jones Industrial Average and replaced by Cisco Systems Inc. and Travelers Cos.

GM, which filed for bankruptcy protection today, and Citigroup, the recipient of $45 billion in taxpayer aid, became the first companies since American International Group Inc. in September to leave the 30-stock average. Their shares have lost more than 90 percent since the start of 2007.

By replacing GM with Cisco, Dow Jones & Co. has removed automakers from the best-known benchmark for U.S. stocks, saying in an e-mailed statement that computers are as central to the economy as cars were in the previous century. Citigroup, until last year the world’s biggest financial firm by assets, is being replaced by a company it jettisoned in 2002 and that was once run by its former chairman, Sanford “Sandy” Weill.

“This announcement brings front and center the challenges facing the U.S. economy as it strives to remain competitive,” said Alan Gayle, director of asset allocation at Ridgeworth Investments, which manages $60 billion in Richmond, Virginia. “The Dow Jones Industrial Average is becoming less of an industrial average. It’s trying to reflect the broader economy.”

Below $5

Citigroup has traded below $5 a share since mid-January and is in the process of converting $52.5 billion of preferred stock into common shares, giving the U.S. government a 34 percent stake. GM’s ouster was foreshadowed in May by John Prestbo, the Dow Jones & Co. editor in charge of indexes, who said it would be removed in a bankruptcy filing.

GM, whose shares will be suspended on the New York Stock Exchange by the end of the day, closed unchanged at 75 cents. Citigroup fell 0.8 percent to $3.69.

“The parlous state of GM has left us with no choice but to remove it from the Dow,” said Robert Thomson, managing editor of the Wall Street Journal, in a statement announcing the change. The newspaper’s editors decide the makeup of the average. News Corp., the media company headed by Rupert Murdoch, has been its publisher since acquiring Dow Jones in 2007.

Travelers Merger

Citigroup, based in New York, was formed in 1998 from the merger of Travelers Group Inc. and Citicorp. In 2002, Citigroup gave up control of Hartford, Connecticut-based Travelers Property Casualty Corp. through an initial public offering and subsequent spinoff. The bank earned $1.6 billion in the first quarter of 2009, ending five straight quarters of losses totaling $37.5 billion.

“We were reluctant to remove Citigroup at the height of the financial frenzy, but it is clear that the bank is in the midst of a substantial restructuring which will see the government with a large and ongoing stake,” Thomson said.

Thomson said Citigroup may be considered again after it has “refashioned itself,” according to the statement.

Cisco, the world’s largest maker of computer-networking equipment, joins Microsoft Corp., International Business Machines Corp., Intel Corp. and Hewlett-Packard Co. in the Dow, boosting its technology weighting from about 17 percent. With the addition of San Jose, California-based Cisco, computer companies will close the gap with industrials including 3M Co., the largest category with about 18.5 percent.

Cisco gained 5.4 percent to $19.50, outpacing a 2.6 percent advance by the Standard & Poor’s 500 Index.

Bank Shares

Travelers, the second-biggest U.S. commercial insurer, joins JPMorgan Chase & Co., American Express Co. and Bank of America Corp. among financial companies in the Dow. Its higher price than Citigroup’s will boost the benchmark’s financial weighting to about 10 percent from about 7 percent. Financials make up about 14 percent of the S&P 500, a broader benchmark.

The choice of New York-based Travelers restored an insurer to the Dow average, which had lacked one since the removal of AIG. Travelers rose 3.1 percent to $41.91.

Kraft Foods Inc. was named to replace AIG in the Dow average on Sept. 18, the day after the nation’s biggest insurer was taken over by the U.S. government to avert its collapse.

GM, which had its last profitable year in 2004, was the worst-performing company in the average last year, losing 87 percent, and 77 percent this year through May 29. Its shares fell below $1 on May 29, putting them below the minimum normally required to trade on the NYSE. GM, based in Detroit, entered the 113-year-old index in 1915, replacing preferred shares of U.S. Rubber.

GM has been in the Dow average continuously since 1925. Only General Electric Co., a component since 1907, has been in the index longer. Travelers joined in 1997, and the company’s name changed to Citigroup in 1998.

Biggest Bankruptcies

GM, the fourth-biggest bankruptcy in U.S. history after Lehman Brothers Holdings Inc. and Washington Mutual Inc. in September and WorldCom Inc. in 2002, had been the lowest-priced company in the average for most of the past year. Citigroup closed at lower prices than GM on 27 days this year, mostly in March. The Dow average is price-weighted, meaning the lower a company’s share price, the less influence it has.

GM and Citigroup were taken out from News Corp.’s 150-stock Global Dow in April, less than five months after that index was introduced.

“The issues facing GM have been widely known and disseminated for some time,” said Jonathan Armitage, head of U.S. large-cap equities at the American unit of Schroders, the U.K.’s largest independent money manager. “It was less a question of if but of when” this day would come.

The Dow average was devised in 1896 by Charles H. Dow, co- founder of Wall Street Journal publisher Dow Jones & Co. Originally containing 12 stocks, it expanded to 20 companies in 1916 and to 30 in 1928.

Reputation, Growth

There are no rules for inclusion in the gauge, according to the Dow Jones Web site. Usually, a stock is added only “if it has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors and accurately represents the sectors covered by the average,” the Web site says.

Changes in the composition of the average “are rare, and generally occur only after corporate acquisitions or other dramatic shifts in a component’s core business,” the site says. “When such an event necessitates that one component be replaced, the entire index is reviewed,” and “multiple component changes are often implemented simultaneously.”

Three companies left the Dow last year, including AIG. Altria Group Inc. and Honeywell International Inc. were replaced by Bank of America and Chevron Corp. Those changes were the first since 2004.