On Monday, Tesla Will Join The S&P500: Here's What Happens Next

Cars Parked In Front Of Company Building

One of the most anticipated and material changes to the S&P500 is set to take place in just hours, when Tesla - a $615 billion company that has barely generated any GAAP profits in its operating history - is set to join the world's most important market index.

What happens then? Well, as with every other thing in the market, there are two schools of thought.

According to one, which Bloomberg affectionately calls the Wall Street smart beta data nerds - Tesla will be a drag on the index. These "smart beta" quants believe that market-weighted indexes suffer by chaining their fortunes to big and bloated companies. As such, Tesla’s imminent entry into the S&P 500 is stirring their passions by framing the debate in particularly stark terms. According to Bloomberg, index pioneers such as Rob Arnott are making the rounds and publishing studies in the run-up, "trumpeting data that purports to show that megacap companies have the potential to harm passive returns." Their pessimistic view coincides with that of the smart-beta folks who say many stock indexes stumble when the massive companies that dominate them run out of room to grow.

In a recent paper titled "Tesla - The Largest-Cap Stock Ever to Enter S&P 500: A Buy Signal or a Bubble?”, Arnott and a colleague at Research Affiliates looked at 31 years of data and found that when a company is big enough to enter the index as one of its 100 largest members, it falls 7% over the following year, on averageMeanwhile, the average deleted company beats the gauge by 20% after being kicked out (in this case, Tesla is replacing Apartment Investment and Management which is down 46% YTD).

According to Arnott, the data is evidence that benchmark overseers such as S&P Dow Jones Indices “buy high and sell low,” resulting in a performance gap of 24% between megacap entrants and discretionary deletions over the next 12 months That ends up costing investors money, and exposes what quants such as Arnott consider a fundamental flaw of market-cap indexes - "too much dependence on companies whose best days may be behind them."

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William K. 4 weeks ago Member's comment

It will be quite interesting to see when that bubble DOES burst If it is on Dec 23, a genius will be announced and hated "for causing the burst." Or for being right. I have always wondered how watching giants can provide any insight into the state of small folks,, and it seems that the answer now may be "who cares", not really the best attitude. The market is always interesting to watch seeing folks throwing millions around based only on emotions.

The considerations presented are certainly valid and it is always interesting to see how opposite opinions can both be right.