09/17/2020

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The Evolution of the World’s Most Watched Indexes



COVID-19 May Cause Companies to Fall From the S&P 500


Around the world, stock market indexes are important barometers for investors. They shed light on everything from country-specific economies to individual industry sectors within each country. In the United States there are roughly 5,000 indexes. That being said, Wall Street and the world are generally most concerned with just three: the 30-stock Dow Jones Industrial Average, the tech-heavy Nasdaq Composite benchmark, and last but not least, the broad-based S&P 500 Index.

The Standard & Poor’s 500 Index is made up of the 500 largest publicly traded companies in the US on a market-capitalization basis. Market cap, as it’s often abbreviated, is calculated by multiplying the total number of outstanding shares of any company by the current market price of one share. In March, share prices of many companies plummeted as the coronavirus pandemic set in. Since then, the index has made a striking recovery, although the rebound was mostly driven by certain technology and healthcare stocks.

Companies currently in the S&P 500 index that have been most damaged by coronavirus now run the risk of being removed. In fact, more than 30 firms fall into this category. Furthermore, although the index is considered “passive,” there are active measures being taken behind the scenes by the S&P committee, which uses the 41-page S&P US Indices Methodology rule book to decide whether certain companies were hurt enough by COVID-19 to be ejected from the index.

The evolution of the index matters because there are funds specifically designed to track stocks in the benchmark. For example, the Vanguard S&P 500 tracks the S&P 500 index and has $44 billion in assets. For context, companies that were already booted from the index over the past 36 months are down nearly 50% this year. Had they remained, their performance would have drastically weighed on passive funds, which is why the index needs to be constantly monitored.

Tesla Races for Addition to S&P 500


If some companies are ejected from the index based on poor performance, that would leave room for other up-and-coming enterprises to join the fold. One company specifically appears to be racing to be part of the club: Tesla (TSLA). If CEO Elon Musk is able to help his high-profile electric vehicle company meet the requirements for being included in the S&P 500, this would not only usher in external validation, but it would also encourage index funds to include Tesla in their holdings.

Tesla already scratched the surface of the S&P 500 index by narrowly missing a profit requirement with its first-quarter results. Along with other conditions, a company’s most recent quarter must be profitable. Some are speculating that this is why Musk recently defied authorities and reopened the Tesla plant in Fremont, California.

Although generating a profit in the second quarter may seem like a longshot, given the fact that Tesla’s lone US car plant was shut down for nearly half the period, some investors think overseas operations could help the EV-maker eke out a profit. In fact, the former CEO of Aegon Asset Management, Gary Black, believes that reopening in California, along with delivering on a backlog of inventory, could help Tesla churn out a measly $2 million in profit for the current quarter. Black believes if that happens, Tesla would likely join the S&P 500.

Hong Kong Looks to Update its Index


As drama unfolds with the S&P 500 index in the United States, other global benchmarks are revamping their inclusion rules as well. Take Hong Kong’s famous Hang Seng Index, which will soon allow shares with unequal voting rights or primary listings outside of Hong Kong to join the benchmark. One of the biggest names that may benefit from the changes to the 50-year-old index is Alibaba (BABA), the Chinese e-commerce behemoth. Companies like Xiaomi Corp (XIACF) and Meituan Dianping (MPNGY) might also be able to meet requirements.

Although the new rules and subsequent reviews will not be implemented until August, the index overhaul is seen as an important strategy to win listings from Chinese tech and biotech companies. In short, the possibility of being included in the main benchmark could help attract more listings in Hong Kong. Lastly, the Hang Seng index is currently weighted towards banks, insurers, and real estate developers. Proponents of the changes say the index would be more representative of the modern-day economy with the inclusion of tech and biotech companies. After public consultation in January, more than 90% of respondents supported the proposed changes.


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