The Little Kingdom That Could

The Little Kingdom

Once upon a time, there was a glorious little kingdom within a larger Empire. It ruled at a time when there was no opposition to its power, as nobody else could approach its singular determination to dominate its locale. Sure, there were minor challenges to its authority from time to time, but it brushed them off like so many fleas off of a dog's back. The rulers were young and vigorous, and in fact that was part of the kingdom's charm, for it allowed nobody to grow too old before sending them off to a happy retirement in the lush land's verdant valleys and golf courses.

The kingdom, however, was too successful for its own good. While at first loved and cheered, gradually a growing chorus of envious peons complained that the kingdom was simply getting too big and powerful within the Empire. The kingdom was not allowing other, competing kingdoms to survive, much less challenge its authority. While the kingdom argued, with complete justification, that this was in the best interests of the peasants and farmers, who benefited from its protection and devotion to improving their tools, the detractors responded that others had a right to help the people as well. They said that the Empire would be even stronger if the little kingdom were not quite so powerful.

Matters finally came to head when the Emperor in far-off Xanadu started noticing that the kingdom's popularity rivalled even his own. The people were writing songs and singing carols about the kingdom, while the Emperor, preoccupied with foreign wars and growing disaffection among the people, became hated and feared. Prodded on by his advisers, the Emperor finally instructed his Seneschal to "take care" of the kingdom and disrupt its growing influence.

The Seneschal was a wise man. He flattered the kingdom by telling it that it was so important to the Empire as a whole that it should be broken up into smaller kingdoms, making it into even more of a good thing for the people. At first the kingdom resisted, but the Seneschal was firm, and he camped his troops on the bluffs high above the kingdom's capital as a warning. The kingdom appealed to the wisest men in the Empire, but they finally agreed with the Seneschal. At last, in order to maintain its existence, the kingdom did as the Seneschal demanded. The king split his domain between his several sons and daughters, while maintaining only the prosperous capital for himself.

Everybody expected the kingdom to finally die, but a curious thing happened. Over time, the capital developed into its own little kingdom again, but instead of making tools for the farmers and peasants, it now set out only to advise the little kingdoms of the sons and daughters that had been split off from it. The capital still was so revered by the people, and had accumulated so much prestige and wisdom over the years, that everybody respected and followed its advice. In this way, the capital became even more powerful and influential than the original kingdom had been, but nobody in far-off Xanadu even noticed.

IBM

Now, given the title of this article, it no doubt is apparent that I am addressing in my own whimsical way the story of International Business Machines. While many think that IBM's glory days are long past, in fact IBM remains a preeminent corporation. Having remarkably transformed itself from a hardware company to a services one, it arguably is the most influential company in the world as of the date of this writing.

That's not just a rhetorical talking point. As of April 20, 2013, IBM has the highest percent weighting in the widely followed Dow Jones Industrial Index. It is the only stock that carries a weighting above 10% in that Index. In fact, it is the only stock that carries a weight above 9%, and above 8%, and above 7%. The closest weighted stock, in fact, is Chevron at all of 6.123%. IBM's weighting in the S&P 500 is much, much lower, at around 1/10 of 1%, but it remains widely followed and news about it has an out-sized effect upon the stock market. You may dismiss the Dow Jones Industrial Average as an outdated, biased, somewhat odd relic of the 20th Century. It still influences the average investor on the street, regardless of what we think. But, we don't have to look at the Dow Jones at all to see IBM's impact.

IBM vs. S&P 500 2000-2013

It is easy to dismiss IBM as a stock that stopped being a bellweather back during the Reagan years. The fact is, as the above chart of the S&P 500 over the past dozen years shows, there has been a very close correlation between IBM and the S&P 500 since 2000 as well. It is, in fact, remarkable. The area of greatest divergence began in 2009, when the market oversold based on near-panic conditions which IBM, serenely confident, shrugged off.

"Well, that correlation ended long ago," you probably are thinking to yourself. After all, nobody really talks about IBM much anymore, it's all about Apple and Facebook and that "old dinosaur tech firm" Microsoft. Intel and Cisco used to get that sort of press, too, but IBM has outlasted better companies than those.

Let's look at another chart:

IBM vs. S&P 500 2008-2013

The connection over the past five years between IBM and the S&P 500 is still extremely tight. One could make the argument, especially given its heavy weighting in the indexes, that IBM has been instrumental in dragging the entire stock market up over this period, leading the way ever since the financial problems began in 2008. But look closely - when IBM dips, the broader market also tends to dip. When it surges, the broader market does likewise. Naturally, they do move at different rates. They very, very rarely diverge in direction.

You probably still are doubting this correlation, which you are sure ended long ago because now it is "just a coincidence" and "IBM's influence ended long ago." Let's look at one last chart.

IBM vs. S&P 500 2012-2013

If the correlation between IBM and broader market is just a coincidence, it is a remarkable one. I want to be clear that this has nothing to do with any outsized weighting of IBM in these charts: IBM has only its relative market cap to influence the S&P 500 charts at which we are looking.

The astonishing thing from looking at the charts of actual performance, and not simply relying upon our outdated notions, is that the correlation between IBM and the broader market has become tighter with time, not looser. A "bellweather" stock is one that either leads the market, or follows closely along with it in fairly tight lock-step manner. That definition fits IBM. That's right - today, in 2013, IBM is more of an actual market bellweather than ever! "As IBM goes, so goes the market" was a saying back in the 1970s. It remains even more apt in the 2010s.

This is simply to show how important IBM is to the market. IBM may not always lead the market - but it sure does a good imitation.

One last chart, comparing SPX and IBM:

IBM (purple) vs. SPX (candlesticks)  2013

This shows the extreme, uncharacteristic divergence between IBM and the broader market. Something is going to give - eventually they will return to harmony, because they always have in the past.