Teslaâ€™s move into the S&P 500, which is official come Monday, will spark the biggest index rebalancing in history, but the market implications could be far greater down the line as the volatile stock becomes a top-ten holding in the multitrillion-dollar world of passive investing.
Teslaâ€™s market capitalization of $620 billion would command about 1.5% of the S&P 500â€™s total market value when it enters the index after todayâ€™s close, just ahead of Alphabet but behind Facebook.
That kind of historic entry into the S&P 500 means a massive amount of trading ahead of the official move that could amount to nearly $100 billion as investors tracking the index sell shares of companies in the S&P and buy up Tesla.
Most of that action should happen today without much of a mechanical hitch: â€œThe market is pretty efficient when it comes to handling this type of volume and a lot of that technicality,â€ says David Barse, the founder and CEO of index firm XOUT Capital.
The majority of the selling will be out of tech heavyweights that are well equipped for monster trading volume, says Socorro Asset Management Founder Mark R. Freeman, who estimates some $8 billion could come out of Apple alone, the largest S&P component by weight with about 6% of total value.Â
But there could very well be price volatility in the Friday session, notes Vital Knowledge Media founder Adam Crisafulli, as the trading influx could put outsize price pressure on the dozens of making up less than .05% of the S&Pâ€™s market value that donâ€™t usually see such high volume, especially at the close, when a rush to complete trades is likely.
Teslaâ€™s meteoric rise this year (which has been met with high volatility) would make it the S&Pâ€™s seventh-largest component based on Friday prices (ahead of Berkshire Hathaway, JPMorgan and Visa)â€“boosting the price sensitivity of an index thatâ€™s grown to be more concentrated than ever.
â€œTo go from not being in the index at all to now being a top-ten name in it is pretty, pretty significant, and especially in a name like Tesla,â€ says Freeman. â€œYes, itâ€™s had a great run, but at the end of the day, from a business standpoint, even founder Elon Musk has said, hey, if we donâ€™t hit our numbers, we can get crushed,â€ he adds, referencing an email Musk sent to employees in early December. In the note, first reported and obtained by Electrek, Musk said realized profit margins of around 1% have been â€œvery lowâ€ and that investors are giving the firm â€œa lot of creditâ€ for future profits. Musk then warned: â€œIf at any point, they conclude thatâ€™s not going to happen, our stock will immediately get crushed like a soufflÃ© under a sledgehammer!â€
Tesla shares have surged 64% since S&P Global announced the stockâ€™s addition to the S&P in November. The stock is now up an eye-popping 680% this year.
Index rebalancing is not uncommon in the stock market, but itâ€™s never happened on this scale. And as bigger companies join the S&P, experts are finding that momentum built up before a firmâ€™s index inclusion doesnâ€™t always last. â€œIf you go back historically and look at the last two additions on this scale: One was Berkshire Hathaway, it came into the S&P [weighted] at roughly about 1.2%, and Facebook came in at about 1.5%,â€ says Freeman. â€œYou tend to see this significant outperformance heading up to the inclusion, and then [the stocks] tend to underperform going forward.â€ Berkshireâ€™s index weight is about flat since its S&P debut ten years ago, while the 30% runup in Facebookâ€™s stock this year has pushed its weight to about 2.1%, though shares did initially underperform the market in the weeks after its December 2013 addition.
Some Wall Street observers worry Teslaâ€™s addition to the S&P has come too late. â€œThe value of the S&P 500 index would be $566 billion higher if Tesla had been included on its trading debut,â€ says Vincent Deluard of publicly traded financial services firm StoneX, arguing that the indexâ€™s selectivity has led it to underperform a simple basket of the 500 largest publicly traded companies. “Investors have not complained because the S&P 500 indexâ€™s tilt toward large caps allowed [it] to beat 72% of U.S. stocks in the first eight months of the year, but that performance has reversed since September.â€
In a Wednesday note, Goldman Sachs said that Teslaâ€™s S&P inclusion will have only a â€œde minimis contribution to index earningsâ€ and that its price/earnings valuation multiple of 170 is nearly 8 times the average of 22 in the S&P (roughly the same with and without Tesla).
The S&P 500 Grows Ever More Concentrated (Morningstar)