Opinion - Quarterly Investment Guide

The truth about Dow's GE dump: DJIA is the market ticker that is irrelevant 

David Martin, chairman, M-CAM International, and managing partner of Purple Bridge Management
Key Points
  • The Dow Jones Industrial Average selection committee said GE was dropped due to the waning significance of industrial stocks.
  • It's the DJIA selection process itself, though, which is proving to be irrelevant to the market.
  • Adding Walgreens Boots Alliance to the Dow two days before Amazon entered the pharmacy market through its PillPack acquisition helps prove the point.

The removal of General Electric from the Dow Jones Industrial Average after 111 years says more about stock market indices than it does about GE.

Traders work on the main trading floor of the New York Stock Exchange as the Dow Jones industrial average passes the 20,000 mark shortly after the opening of the trading session on Jan. 25, 2017.
Brendan McDermid | Reuters

In the statement announcing the addition of Walgreens Boots Alliance, David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices, said that “consumer, finance, health care and technology companies are more prominent today, and the relative importance of industrial companies is less. …. Today’s change to the DJIA will make the index a better measure of the economy and the stock market.”

As the CNBC IQ100, powered by M·CAM, has clearly demonstrated, the DJIA continues to struggle to find relevance in the face of macroeconomic conditions and altered market dynamics.

The price-weighted nature of the DJIA makes it increasingly susceptible to factors that have more to do with market activities of individual corporations than broader market conditions. While the index committee at S&P Dow Jones Indices may have chosen Walgreens for its price and sector representation, it may have overlooked a critical aspect of the mandate to measure the economy.

Two days after Walgreens was added to Dow, Amazon entered pharmacy business

Walgreens Boots Alliance is not a market innovator. As a consumer retail outlet primarily for the pharmaceutical industry, the firm’s intellectual property holdings are negligible. Where industry leaders have been focused on drug-interaction detection, drug counterfeiting, customizable dosing and the like, Walgreens is dependent on the technology of others.

The majority of Walgreens’ pending patents are subtle variations on data, inventory and prescription management business methods, which offer little to no market differentiation. Virtually all of the Boots Company PLC legacy patents on store-brand cosmetics or pill packaging are expired or soon to expire. In its 2017 annual report, the company states that approximately 98 percent of its prescription sales came from managed care and governmental reimbursement programs. In other words, the majority of Walgreens Boots' business is more a proxy for managed health care than it is a reflection of consumer products.

The selection of Walgreens for inclusion into the DJIA continues to challenge the relevance of an index branded as an “industrial average.” As index-linked investment activity continues to expand through the proliferation of exchange-traded funds and other indexing products, the increasing homogeneity of the Dow, the and the Russell methodologies converge on consensus insights rather than on meaningful market insights.

In contrast, Amazon has been leading the consumer market for years in fundamental innovation. From logistics and warehouse technologies that increase ease of product supply and delivery to robotics and automation technologies that supersede technologies from companies like NCR and Diebold, Amazon has integrated cutting-edge innovation development and deployment into its business unlike any other market participant.

With Amazon’s recent acquisition of PillPack, the integration of pharmacy fulfillment and patient-data analytics into Amazon’s existing business may further undermine the Walgreens relevance not only on the Dow but in the broader market as well.

— By David Martin, managing partner of Purple Bridge Management and chairman of M-CAM International, which created the CNBC IQ 100 Index with CNBC