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Dow Jones Changes Its Composition

August 28, 2020 By Mircea Vasiu

Dow Jones, the famous U.S. stock market index, changes its composition once again. After introducing Apple a few years ago, Dow Jones has made another important change – Exxon will leave the index after being listed for a century and will be replaced by Salesforce. 

In addition, Honeywell replaces Raytheon Technologies and Amgen kicks Pfizer out. All three changes will become effective September 1st, affecting passive investors’ portfolios.

New Entrants Fueling Strong Dow Performance

The new changes alter the composition in the Dow Jones index as energy is replaced with tech. Salesforce trades at all-time highs, fueled by a string of good news this week.

First, the Dow Jones inclusion triggered buying orders. In order to match their portfolios with the new composition, passive managers must add the new entrant’s shares, while selling the shares of the company that leaves the index.

Second, Salesforce reported strong earnings this week and lifted the year’s outlook. Finally, the Fed signaled at the Jackson Hole Symposium that it is willing to keep the rates lower for longer.

The positive news sent Salesforce on a higher tear. It currently sits at $276 pre-market, after trading at $200 at the start of the trading week.

The shift towards greener investments and the fight against climate change affects companies like Exxon. The increasing ESG practices and governments shift to green legislation is likely to continue in the future and put pressure on the energy sector.

With the new changes, the Dow gets a new face. Curiously, the decision was triggered by Apple. Apple announced a split stock, and that changed the Dow’s weight in the IT sector.

Unsurprisingly, Pfizer, Exxon, and Raytheon Technologies are all down on the week. Over $28 billion are indexed to the Dow Jones, and to reflect the changes, passive investing strategies should sell the three names.

Because the Dow wants to pivot the index towards the technology sector, Apple’s decision to split the stock brought less, not more exposure. The new entrant, Salesforce, solves for the issue, as the Dow is a price-weighted index, and the divisor will be changed ahead of September 1st to reflect the new changes.

Does this mean that the companies that leave the Dow will underperform the market? Not at all. In the last two decades, no less than 17 companies left the Dow Index. After the initial reaction, they all recovered and did just fine.