S&P Rips The Tesla Band-Aid. What To Expect Next.

Yesterday afternoon found investors glued to their news sources at 5:15. S&P Dow Jones Indices stated that they would be releasing the methodology that they would be using for Tesla’s (TSLA) inclusion into the S&P 500 Index (SPX).On November 16th, S&P announced that TSLA would be joining SPX on December 21st but left some ambiguity about how they would actually go about handling the largest addition to the index in its history. That ambiguity was removed yesterday when they declared that the index addition would be handled in one fell swoop at the close of trading on December 18th.In one sense, that is a relief. It would probably not be the best time to attempt a new index addition methodology during the largest addition in its history. But there will be many ancillary effects from that move. We will attempt to address some of them here.

That TSLA rallied about 5% on the news was hardly surprising.TSLA tends to rally on any news that can be reasonably interpreted as even mildly bullish. That stance has worked for its faithful investors throughout the years. With the stock around all-time highs (yet again) and having risen about 40% in the two weeks since the initial S&P announcement, that faith has been continually rewarded.

It is important to understand just how meaningful this addition is both to TSLA and SPX. The index is weighted by market capitalization, and TSLA sports a market cap roughly equal to that of Berkshire Hathaway (BRK-B). That implies that TSLA would sport a similar index weighting to BRK.B, which is about 1.5% of SPX, but since SPX uses free float in its calculations that lowers the projected weight to about 1.2%. The committee has not yet announced which company will be replaced by TSLA, but it is safe to assume that TSLA is magnitudes larger. There can be little disruption when the incoming company is similarly sized to the outgoing one. But when there is a significant disparity, index funds are forced to sell pro-rated stakes in the other 499 index components to raise the funds necessary to purchase the new name. Almost all money flowing into TSLA will by necessity need to come out of the rest of the index. That is likely to pressure the index on or around December 18th

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