How NVIDIA Could Break a Proven Stock-trading Strategy by Booting Intel From the Dow

Nvidia's recent replacement of Intel in the Dow Jones Industrial Average marks more than a symbolic shift. It represents a pivotal test of whether traditional market patterns can withstand the transformative forces of the artificial intelligence (AI) era.

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Historically, being removed from the Dow has often proven advantageous for companies. Research from Research Affiliates indicates that between 1991 and 2023, stocks removed from major indexes outperformed their replacements significantly. In fact, a portfolio of deleted stocks during this period would have made investors 74 times wealthier than the alternative.

This trend is not new. A Pomona College study analyzing data from 1928 to 2005 found that in 32 out of 50 instances, stocks removed from the Dow outperformed their replacements. On average, deleted stocks gained 19.3% in value 250 trading days after removal, compared to a mere 3.37% rise for newly added stocks. By five years, deleted stocks typically grew to 2.73 times their initial value, while additions only reached 1.65 times.

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The most striking example of this pattern is IBM’s removal from the Dow in 1939 in favor of AT&T. By the time IBM was reinstated in 1979, its value had multiplied 562 times, while AT&T's growth was comparatively modest. This single decision significantly contributed to the historical success of the deletion effect.

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What explains this phenomenon? According to Research Affiliates, two key factors are at play. First is long-horizon mean reversion, where companies are often removed at their lowest point, setting the stage for recovery. Second is the liquidity effect, as stocks removed from an index experience sell-offs that push their prices below their fundamental value.

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This effect has been amplified in recent years, with index funds now controlling over 20% of the S&P 500’s total market capitalization. Forced sales by these funds can create substantial downward price pressure, offering opportunities for recovery.

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The consistency of the deletion effect is notable. Deleted stocks often outperform benchmarks like the Russell 2000 Value Index, exceeding it by an average of 18% in positive years. In 2009, deletions outperformed the benchmark by an extraordinary 90%. Even in years of underperformance, the shortfall averaged only 5.3%.

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However, a closer look at Dow changes after 2005 suggests the deletion effect may be weakening. A study by Dividend Growth Investor found that in only four of the last 14 cases did deleted stocks outperform their replacements. Between 2005 and 2023, $10,000 invested in each Dow deletion grew to $180,609, while the same amount invested in Dow additions rose to $227,540.

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This reversal may reflect the accelerated pace of technological change. Nvidia and Intel illustrate this shift vividly. In just eight years, Nvidia has grown from a $22.3 billion company to a $3.6 trillion behemoth, commanding up to 95% of the AI chip market. Meanwhile, Intel has seen its CPU market share shrink to 62% as rival AMD captured a record 35.5%. These figures highlight how quickly technology companies can rise—or fall—compared to the gradual shifts of the past.

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The semiconductor industry, in particular, operates under a different set of rules than traditional sectors. Legacy industrial giants could sustain their dominance through size and manufacturing capability, but today’s tech firms face a far more dynamic environment. Market leadership can shift dramatically in just a few quarters, with rapid ascents often matched by equally steep declines. This fast-paced evolution diminishes the likelihood of the gradual recoveries that once characterized deleted stocks.

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Moreover, companies that gain a technological edge now tend to entrench themselves in ways older industries never did. Nvidia’s CUDA platform, for instance, has become a cornerstone for developers and businesses building AI applications. This creates a self-reinforcing ecosystem that makes it challenging for competitors to catch up. Market dominance is no longer about just making superior products; it’s about becoming the foundation upon which others innovate.

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For investors, the Nvidia-Intel switch presents a dilemma. On one hand, historical patterns suggest Intel could outperform following its Dow removal, thanks to its enduring manufacturing strengths and significant CPU market share. On the other hand, Nvidia’s leadership in AI and its broader ecosystem raise doubts about whether the traditional mean-reversion narrative applies.

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Perhaps the more profound question isn’t whether Intel will outperform Nvidia but whether the metrics we use to evaluate market leadership remain relevant. In an age where AI is reshaping industries at unprecedented speeds, traditional benchmarks like Dow membership may no longer capture the full picture of value creation.

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Ultimately, the Nvidia-Intel exchange could symbolize a broader turning point. Beyond testing the validity of the deletion effect, it challenges investors to rethink how they navigate markets in an era defined by rapid technological disruption. The transition may be remembered as the moment when old frameworks gave way to new paradigms, requiring a recalibration of how we measure success in the modern economy.

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