The S&P 500 might soon have a slightly new look because it is about to be rebalanced every three months.
Based on past trends, S&P Dow Jones Indices could add new companies to the main large-cap U.S. stock index after the market closes on Friday. The index source would then list the parts that were going to leave the S&P 500 SPX +0.11%.
When it is reported that a stock will be added to the S&P 500, its price usually goes up. This is because trillions of dollars are invested in index funds that track the benchmark.
That means those index funds have to buy the new stock that’s being added to the index. Steve Sosnick, chief strategist at Interactive Brokers, says, “so it’s a clear source of demand over a defined period, from whenever the announcement occurs to whenever it transpires.” This is usually a short window.
When new companies join the market, it’s usually not a surprise. This is because the companies are usually well-known and have recently met the financial requirements. They are also usually big parts of the S&P MidCap 400 Index (MID -0.07%) or the S&P Small Cap 600 Index (SML -0.17%).
The S&P Composite 1500 Index SP1500 +0.12% is made up of these charts and the S&P 500.
Sosnick said, “Markets are kind of efficient.” “They tend to plan ahead.”
Companies have to meet a number of requirements before they can be added to the S&P Composite 1500. Some of these are having an office in the U.S., having positive earnings per share over the last four reported quarters, and being profitable for the most recent reported quarter. For companies to be in the S&P 500, their market value must be at least $18 billion. For the other indexes, the market value requirements are smaller.
Various names have been floated as candidates for S&P 500 inclusion this time around, including financial-technology plays Coinbase Global Inc.
COIN +7.77% and Block Inc. SQ +2.48% , software company Workday Inc.
WDAY +2.35% and used-car retailer Carvana Co. CVNA -2.69%
There is an index group that makes the choices, and Sosnick says they are “more art than science.” The S&P 500 is more than just a list of the 500 biggest companies by market value. Instead, the group might try to stay away from parts that are very likely to change or focus on different qualities at different times.
Sosnick said it was like getting into college. “You know what you need, but just because you have it doesn’t mean you’re going to get it.” The school may need a tuba player for the band more than a SAT test-taker.
In discussing the potential for Block to join the S&P 500, Bernstein’s Harshita Rawat noted that “sector diversification is one of the index committee’s considerations, in that they aim to maintain a sector composition that is generally in line with the economy.”
What “in line with the economy” means isn’t perfectly spelled out, but Rawat highlighted that financials currently make up 13.9% of the S&P 500, compared with 14.6% in the S&P Total Market Index, “suggesting that there is room for a financials addition since they are underrepresented.”
Owen Lau of Oppenheimer also pointed out Coinbase as a possible option over the summer. It is one of the largest companies by market value that doesn’t yet make the index because it doesn’t meet other requirements.
