Dow Jones announced that General Electric (GE) will be removed from the Dow Jones Industrial Average (DJIA) and replaced by Walgreens Boots Alliance Inc. The reason provided for removing GE was its low price. For an index such as the S&P 500, which is capitalization weighted, a stock is removed because its market cap becomes too small. The DJIA is price weighted, so a stock is removed because its price is too low. Apple split its stock 7 to 1 in order to lower its price so it could be added to the DJIA in 2015, but at $12, GE represented only 0.5% of the DJIA by price and so it was removed. If the DJIA had been cap-weighted, GE probably would not have been removed. The market cap of GE is $111 billion while the market cap of Walgreens Boots Alliance is $67 billion. Perhaps a reverse split could have kept GE in the Dow. General Electric was one of the original members of the Dow Jones Industrial Average when the average was introduced on May 12, 1896. GE was removed from the DJIA on September 15, 1898 when it was replaced by United States Rubber (later renamed Uniroyal). GE was put back in the DJIA on April 21, 1899 when the DJIA switched out four stocks in the index. General Electric was removed a second time on March 31, 1901 when five stocks were removed and added to the DJIA. General Electric was added to the DJIA for the third time on November 7, 1907 when GE replaced Tennessee Coal, Iron and Railroad after the latter company was absorbed by U.S. Steel. General Electric was in the DJIA for the next 111 years. General Electric’s decline has been steady during the 21st century. In 2000, GE’s market cap was over $500 billion and as recently as 2005, General Electric was the largest company in the world. Since then, GE has lost over $400 billion in market cap, and today, GE doesn’t even make the top 50 in the world.  

Thomas Edison Founds General Electric

General Electric began as the Edison Electric Light Co. which was founded by Thomas Edison in 1878. When Edison Electric Light Co. shares debuted in 1881, investors had high hopes for the company, and its shares were trading at over $1000 a share, ten times its par value. However, the cost of developing electric power exceeded expectations and the price of the stock steadily declined, falling to $50 by the end of 1884. Edison Electric Light wasn’t even able to pay a dividend until 1888. A chart of the Edison Electric Light Co. is provided below.

Thomas Edison Signature from Edison Storage Battery Company Stock Certificate

 

Edison Electric Co., 1891 to 1889

  Edison General Electric consolidated with the Bergmann Co., the Edison Lamp Co. and the Edison Machine Works into the Edison General Electric Co. in July 1889. The Edison General Electric Co. competed with Westinghouse and the Thomson-Houston Electric Co. to bring electricity to America. Edison favored Direct Current (DC) while Westinghouse and Nikola Tesla favored Alternating Current (AC). As it turns out, Edison made the wrong choice and despite electrocuting elephants and using other publicity stunts to warn people against using alternating current, AC was the more efficient choice. Consequently, Edison General Electric Stock made almost no progress in its three years of existence.  

Edison General Electric Co. 1889 to 1892

  In May 1892, Edison General Electric merged with Thomson-Houston Electric Co. to form the General Electric Co. which still exists today. When the Columbian Exposition took place in Chicago in 1893, Westinghouse won the right to supply power to the exposition, impressing the millions who attended to celebrate the 400th anniversary of the discovery of America. GE stock fell from around 100 at the beginning of the exposition to the 30s by the exposition’s end and stayed at that level for several years. Competition between General Electric and Westinghouse (which was in the DJIA between 1914 and 1925 and between 1928 and 1997) to bring electricity to America was intense. Charles Coffin was instrumental in turning GE into one of the most successful companies of the twentieth century by using efficient management to turn GE into a conglomerate that eventually became the largest company in the world. The chart below shows the steady rise in GE stock from the 1890s to today.  

General Electric Co., 1892 to 2018

 

The Rise of General Electric

During the twentieth century General Electric was involved in many of the innovations that produced the consumer goods that people take for granted today. This included light bulbs, power stations, jet engines, radios, televisions, x-ray machines, CT scanners, MRI machines and thousands of others. GE’s research division had few peers. As was true of Bell Labs, GE’s research division won Nobel Prizes and produced thousands of new products over the course of the twentieth century. GE’s two CEOs in the last quarter of the twentieth century, Reginald Jones and Jack Welch were among the most admired CEOs in the world. While conglomerates fell into disfavor in the 1980s, GE was able to use its managerial skills to grow the GE into being the largest company in the world. Under Jack Welch, however, GE moved away from relying upon its technological innovations and managerial prowess, and it began relying more upon finance as a source of growth. GE Capital began to dominate General Electric and under Welch, GE’s capitalization grew from $14 billion in 1981 to over $500 billion in 2000.  

The Fall of General Electric

GE Capital participated in the growth in the financial sector in the early 2000s, moving into credit card companies, subprime lending and commercial real estate. Financial executives and tax lawyers used their wizardry to borrow in the US and move money to other countries with lower tax rates, both reducing their American tax liability and smoothing out earnings to please investors. When the financial crunch hit in 2008, GE had to be bailed out by the government and sell shares to Warren Buffett to stay afloat. The combination of unwinding GE Capital, making poor acquisitions and slowdowns in its industrial businesses made the shrinking of General Electric inevitable. GE stock was at $158 in May 2000 and the company had a market cap of $517 billion when the company did a 3-for-1 split. Today the stock is at $12 and its market cap is at $111 billion GE’s new CEO, John Flannery is struggling to keep the price from falling into the single digits. During the past decade, GE’s successor has continued to grow. C. K. Walgreen & Co. incorporated in Illinois in 1909 and changed its name to Walgreen Co. in 1916. The stock listed on the New York Curb in 1928 and moved to the New York Stock Exchange in 1934. In 1974, Walgreen stock was back to the point it had been at in 1929, but as Walgreen’s expanded across America in the 1980s and 1990s, the stock rose in price dramatically. Walgreens merged with Alliance Boots in 2014 to form Walgreens Boots Alliance, turning an American company into a global company. Although Walgreens’ growth has slowed since 2000, it didn’t lose $400 billion in market cap as General Electric did. A more logical replacement for General Electric would have been Amazon or Alphabet or Facebook or Berkshire Hathaway. Each one of them is among the ten largest companies in the world, but the problem with each of those companies is that their price is too high to be placed in a price-weighted index like the Dow Jones Industrial Average. At least Walgreens is in the top 100 companies worldwide. Welcome to the Dow, Walgreens.  

Walgreens Boots Alliance, Inc, 1928 to 2018

Many investors are showing an interest in Environmental, Social and Governance (ESG) funds because some researchers believe that these types of funds may offer long-term performance advantages over non-ESG funds. Managers of these funds evaluate companies based upon their corporate behavior and their sustainability over time. Similarly, many funds consider Socially Responsible Investing (SRI) as a criterion for choosing funds to invest in. The goal of socially responsible investing is to consider both financial return and social/environmental factors in choosing firms to invest in. Socially-responsible investors might be concerned over corporations’ impact on climate change or the corporation’s sustainability because of their dependence on depletable natural resources. Social concern over workplace diversity, human rights, animal welfare and consumer rights can also play a role. Corporate governance issues relating to employee relations, executive compensation and the balance of power between the CEO and Board of Directors are also be taken into consideration. Investors may avoid companies that produce products they find offensive, such as tobacco, alcohol or military goods. Interestingly enough, Standard and Poor’s produced indices based upon whether a company produced goods that could be used for war or for peace in the 1940s and 1950s. War stocks included companies in aircraft manufacturing, coal, copper and brass, lead and zinc, machine tools, machinery, metal fabrication, oil, railroad equipment, shipbuilding and steel. Peace Stocks included companies in the business of automobiles, building materials, confectionery, containers, finance, gold and office and business equipment. Because the United States was fighting World War II to defend the country from Axis powers, few people would have objected to investing in war companies, and it should be remembered that Americans were encouraged to buy war bonds to help fund the war. Nevertheless, “war” and “peace” stocks do provide an interesting dichotomy for socially-responsible investors to analyze. The chart below shows the relative performance of war stocks and peace stocks from September 1939 until February 1957. The index begins when Germany invaded Poland in September 1939 precipitating World War II and ends in February 1957 when Standard and Poor’s introduced the S&P 500 and reorganized its indices, eliminating ones such as war stocks and peace stocks which were no longer relevant. So, which was the better investment, the Military-Industrial Complex or Consumer Goods? What is interesting is that neither war not peace stocks outperformed the other until 1944, but as it became apparent that the Allies would win the war, peace stocks began to outperform war stocks and did so until 1946. War stocks outperformed between 1946 and 1949 during the post-war recession, but by June 1950, when the Korean War began, both war and peace stock indices were at the same level. After 1950, however, War stocks were the clear winners. By February 1957, the peace stock index was at 420, and the war stock index was at 542. Peace stocks had provided an 8% annual return while war stocks had provided a 9.5% annual return. It is a pity that Standard and Poor’s discontinued the index in 1957. Eisenhower didn’t give his speech on the Military Industrial Complex until January 1961, the Cuban Missile Crisis occurred in 1962, and the Vietnam War dominated the American economy and politics of the late 1960s and early 1970s. Some commentators have blamed the Vietnam War for contributing to the poor performance of the stock market after 1968. It would have been interesting to see how war and peace stocks performed under those circumstances. Of course, ESG and SRI funds look at a host of issues other than whether a stock promotes war or peace, but the historical data S&P produced provides food for thought.  

The graph below illustrates the history of global stock markets by capitalization from 1900 to 2018. The graph uses the World Federation of Exchanges definitions and divides the world into three groups: the Americas which includes both North and South America, Europe/Africa/Middle East, and Asia and Oceania. It shows how each continent’s share of global Stock market capitalization has changed over time. The Americas represented the majority of global market capitalization during the past 120 years, but the most obvious trend over time is the decline of Europe and the rise of Asia.  

The World in 1900

In 1900, Europe dominated global stock markets. Europe represented about 68% of global stock market capitalization, the Americas around 30% and Asia only 2%. By 2018, Asia had become the second largest continent by capitalization. The Americas represented 44% of global stock market capitalization, Asia 34% and Europe 22%. Europe dominated global financial markets in 1900 and London was at the center of European finance. European countries were on a gold standard that linked all currencies to each other at fixed exchange rates and money flowed freely between European countries. Europe funded railroads, banks, utilities and other companies in Europe and the rest of the world. American railroads were traded on all the major stock exchanges in Europe. In 1900, there were very few stock markets anywhere in Asia, in part because many countries were European colonies. There were stock markets in Shanghai, Tokyo and Hong Kong, and limited trading in Australia, New Zealand and India; however, the value of Asian securities that were traded in London exceeded trading in Asia. Companies that operated in French Indochina, the Netherlands Indies, Malaysia and other European colonies listed in Europe, not on local exchanges. European capital markets had more resources available for investment than Asian capital markets. Until the 1970s, Asia represented a very small portion of global stock market capitalization. The majority of global stock market capitalization was located in North America. Between 1900 and 1970, the Americas grew in size while Europe shrank. The primary causes of this transformation were World War I, World War II and the nationalization of European industry.  

The Decline of Europe

In 1914, Europe represented about 61% of global market capitalization and the Americas 37%. Capital flowed freely from one European country to another. Russia issued bonds payable in Russian Rubles, British Pounds, French Francs, German Marks, United States Dollars, Dutch Guilder and Austrian Crowns. It was truly a globalized world. But on August 1, 1914, all European and American stock markets closed. The flow of capital between countries stopped and stock markets in Berlin and St. Petersburg remained closed until 1917. The St. Petersburg stock market closed for the next 75 years when the Russian Revolution overthrew the Tsar. With Europe recovering from World War I, money flowed into the United States. By 1929, the United States represented 65% of global market capitalization, while Europe’s share had shrunk to 32%. However, the collapse of the American stock market after 1929 pushed the United States’ share of global market cap down to 40% by 1933, whence it recovered. Although there was some recovery in Europe the 1920s, the gold standard broke down in 1931 further reducing the globalization of global financial markets. Governments controlled industry during World War II, and after the war, France, Great Britain and other European countries nationalized their main industries while stock markets in Eastern Europe closed when the Communists seized power. By 1950, Europe’s share of global market capitalization had shrunk to only 18%.  

Dominance of the Anglo-Saxon Four

As Europe’s share of global market cap shrank, the four Anglo-Saxon countries’ share rose. These four include not only the United Kingdom and United States, but Canada and Australia. The United Kingdom played a smaller role in global finance after 1914 as it sold foreign securities listed in London to help pay for the war, but its global reach continued until the start of World War II in 1939. Neither the United States, Canada nor Australia suffered from the destruction of the world wars or the nationalization of its industries as occurred in Europe. By 1950, the three largest stock markets in the world were New York, London and Toronto/Montreal representing 75% of global market capitalization. By the late 1960s, Canada and the United States together represented 75% of global stock market capitalization. The Anglo-Saxon countries’ domination of global stock markets continued until the 1970s as is illustrated in the figure below which shows the Anglo-Saxon Four’s share of global market capitalization from 1900 to 2018. As can be seen, these four countries’ share of global market cap fell dramatically in the 1970s and 1980s. In the 1970s, the OPEC Oil Crisis, stagflation, the collapse of Bretton Woods and other economic problems began shifting the balance of power away from America. The Asian Tigers began exporting goods to the rest of the world. By the 1980s, globalization was back and economic power shifted toward emerging markets and Asia.  

The Rise of Asia

The main factor holding back Asia from dominating global stock markets until the 1980s was Asia. Shanghai had a stock market until the 1940s when it was closed down after the triumph of Communism, and India’s socialistic policies that preferred five-year plans over stock market-driven growth condemned its people to poverty for decades. Since 1970, Asia’s share of global stock market capitalization has increased dramatically. Export-led growth in Japan, Korea, Taiwan, Hong Kong and Singapore allowed those countries’ economies and stock markets to grow. Japan, Korea and Taiwan all went through stock market bubbles in the 1980s and in 1989, Japan’s stock market was larger than the United States’ and the largest company in the world was Nippon Telegraph and Telephone. NT&T’s market cap in 1989 was greater than the entire German stock market. In 1989, Asia represented 45% of the world’s stock market capitalization, Europe 22% and America 33%. However, in 1989, the stock market bubbles in Asia burst and Asia’s share of global market cap plunged to 16% by 1998; however, since 2000, both India and China have significantly increased their share of global market capitalization as Japan, Taiwan, and Korea have recovered from the crash of their stock markets in the 1990s. Asia grew at the expense of the United States up until the 2008 financial crisis and at the expense of Europe since then.  

The Asian Century?

Europe is no longer an engine of growth within the world economy and under Donald Trump, America’s willingness to pursue open trade with the rest of the world is in question. Were it not for the growth in the size of the internet stocks that dominate America’s stock market, Asia’s share of the world’s market cap would have grown even more during the past decade. How long before Asian stock markets become larger than America’s? Hong Kong, Shanghai and Shenzhen continue to attract new IPOs. Meanwhile, India is growing at a dramatic pace. At the current rate of growth, Asia will probably be larger than America by 2030 and have over half of the global market capitalization by 2040, if not sooner. And the more Europeans and Americans fight among themselves over trade, the sooner this is likely to occur.

Banks were in a similar situation. There were thousands of state and national banks spread throughout the country. When the NYSE was founded in 1792, the most important stock in the country was the Bank of the United States which Alexander Hamilton had created. Until the 1840s, banks represented the largest sector on the New York Stock exchange, but in the1840s railroads eclipsed banks in size and after the Civil War, railroads dominated the exchange so much that banks were delisted from the Exchange in 1873. For the next 54 years, no bank stock was listed on the NYSE. Bank stocks continued to trade over-the-counter, but the market for bank stocks was limited to local brokers. New York bank stocks traded in New York, Boston bank stocks in Boston and Philadelphia banks traded in Philadelphia. However, banks were not listed on an exchange that allowed them to be traded throughout the country as the railroads were.  

Banks and Trust Companies Begin a Bubble

Until the 1920s, the primary assets of banks were small business loans. In the 1920s, banks began emulating department stores and went after individuals, offering their customers every type of service possible including personal installment loans, mortgage lending, and providing safe deposit boxes and trust departments. In addition to this, banks began underwriting securities, making loans on shares and provided margin lending for investors. Until the 1920s, unit banking, only allowing one location for any bank, was the law of the land, but in the 1920s some states, such as New York, began allowing branch banking and California allowed statewide banking. Thus, banks were encouraged to take over other banks. State banks could only operate within a single state and nationally chartered banks could only have one branch. When states began allowing state chartered banks to have branches, this put national banks at a disadvantage until the McFadden Act was passed on February 27, 1927 which put state and national banks on an equal footing. National banks located in states that allowed branching were also allowed to open branches. In exchange for this concession, national banks were not allowed to operate across state lines until the 1980s, though bank holding companies were granted this right in the 1950s. As a result, a merger frenzy occurred in the 1920s in which banks consolidated with other banks. Most banks were acquired with new shares, not with cash. Since it was easier to issue new shares than spend cash, bank stock prices started to rise rapidly. As the bull market pressed on, speculators borrowed money to purchase more shares and this helped to increase bank profits making the acquisition of other banks even more attractive. A virtuous circle of higher bank profits, more lending and rising bank stock prices from acquisitions created a banking bubble which could only end with a crash. On September 19, 1927, the NYSE allowed bank stocks to list and trade on the floor of the NYSE for the first time in 54 years, moving the banks out of the Department of Unlisted Securities. A dozen banks, including the Chemical National Bank, Bank of Manhattan and First National Bank listed on the NYSE, though all of them had delisted by 1930.  

Banks Stocks Become Unaffordable

Bank stocks traded at incredible prices until a wave of stock splits in 1929 brought shares back to earth. Sixteen New York City bank or trust stocks traded at over $1000 in 1929, and shares in the First National Bank of New York, which had already had a five-for-one stock dividend in 1901, traded at $8200 in September 1929. By contrast, average per capita annual income in the United States in 1929 was only $750. Bank stocks led the way in the bull market of the 1920s; however, this fact has been ignored because most bank stocks traded over-the-counter in the 1920s and there was no daily index of bank stocks that traders could keep track of. Since bank stocks and shares in trust companies were not listed on the NYSE and did not trade on a daily basis, only bid and ask prices were available for many of the companies. Moreover, bid and ask prices were only published on a weekly basis, so calculating a daily index was just not possible. Nevertheless, Standard Statistics calculated a weekly index of money center (i.e. New York) bank stocks. Moody’s started calculating a monthly index of Bank Stocks in 1929, at the height of the bubble, as well as an index of bank yields. In September 1929, as a result of the bubble, banks stocks had an average dividend yield of only 1.35%. Not surprisingly, the capitalization of banks exploded in the 1920s. Both the National City Bank of New York (later Citicorp) and the Bank of New York had capitalizations over $1 billion in 1929 placing them in the top 10 of all stocks in the USA by capitalization. This made those banks worth more than Sears, Standard Oil of New York and Chrysler, among others.

Bank Stocks Collapse

The bigger they are, the harder they fall. Thousands of smaller banks went bankrupt in the 1930s and even shares in the larger banks fell by 90% or more in the next four years. The Banking Act of 1933 (Glass-Steagall) left banks heavily regulated until the 1980s. Regulation limited the profits of the banks and it took decades for them to recover. Even in 1985, S&P’s Money Center Stock Index was still below its 1929 peak, a level the Dow Jones Industrial Average had passed in 1954.