If the saying that “you’re only as good as your weakest link” is true then investors need to pay attention to General Electric (GE). In the price-weighted Dow Jones Industrial Average (DJIA), GE has 0.38% of an impact on the DJIA. Such a low impact on the index makes the movement of GE on the index almost non-existent. However, the manner in which this ailment in the index is treated says a lot about the overall market.
Leaving aside the fact that General Electric has been in the Dow Jones Industrial Average since 1907, GE is the new, “As General Motors goes, so goes the nation.” It isn’t that GE is as broadly diversified in domestic manufacturing that is the issue, though it broadly impacts many industries, instead, it is the continued share decline and the impact on pensions, insurance, 401k, retirement plans, and bank funds that are being adversely affected by cross shareholding of GE as it has declined into what appears to be oblivion.
The current environment affecting GE reminds us of the spiraling feedback loop of cross-shareholding (zaibatsu) in the Japanese stock market from 1989 to the present. The fact that a clean cut could not be made with badly managed companies due to stock holding relationships only allowed the deferral of addressing the real problems within the market. what was the impact of cross-shareholding on the Nikkei stock index in Japan?
By all accounts, the decline in the Nikkei of –81.87% was due primarily because of the difficulty of disengaging the tangled web of cross-shareholding relationships. Ultimately, improved prospects of Japanese companies came in the form of divesting cross-shareholdings.
In our opinion, the situation is the same with General Electric. The managers of the Dow Jones Industrial Average have allowed the disparity between the top weighted Dow component (Boeing) to go far beyond the norm of the bottom component (General Electric), typically 10 times (before getting kicked out of the index) but now it is more than 24 times the value of GE.
Had GE been removed from the Dow Jones Industrial Average at 10x the value of the highest priced stock in the index (Boeing), GE would have been removed from the index in late August 2017. The fact that GE has been allowed to remain in the index means that the managers of the DJIA are in denial of the problems at GE or are acting at the behest of fund managers hoping for a turnaround before dumping their shares.
Right now, the weakest link in the DJIA is allowed to stay afloat at the expense of millions of retirement funds who are required to hold “blue chip” stocks regardless of performance. GE cannot claim to be “blue chip” especially if it gets booted from the DJIA. Although, the accounting scandals and restatements since the Jack Welch era should have been the first indication that GE wasn’t a “blue chip” stock.
The cascading negative effect of not booting GE from the DJIA is far worse than the impact of kicking it to the curb.