By this point, anyone reading this piece should be well aware that Tesla (TSLA) will be joining the S&P 500 Index (SPX) effective December 21^st. In practical terms, that means that index funds will need to own the stock as of the close of this Friday, December 18^th. Ever since S&P/Dow Jones Indices announced this unprecedentedly large index addition on November 16^th, I have discussed the topic both in this space and in various media outlets. In one case, I described it as “peeling the onion” because this one index addition could have a wide range of repercussions. I will attempt to outline some of them below.

1. Not only is TSLA the largest company to join SPX, this rebalancing has by far the largest spread between the sizes of the companies going in and out. An ideal situation for indexers occurs when one company is acquired for cash and is replaced by a company of similar size. In that situation, the index fund can simply use the cash consideration that it receives from the acquired company and spend it on the new index addition. In this case, TSLA is replacing Apartment Investment & Management (AIV), which recently spun-off Apartment Income REIT (AIRC). The combination of AIV and AIRC are worth just over $6bn.TSLA is about $580 billion larger!
2. Besides requiring sales of AIV/AIRC, the addition of TSLA will require massive selling in the other 498 stocks in SPX. At any given time, an index fund has a fixed amount of investable assets. Those assets need to be balanced to properly represent the index composition. The only way a fully invested index fund can pay for a new index addition is to raise the cash by selling proportional amounts of its holdings. It is estimated that there is $5 trillion explicitly indexed to SPX. Since the market capitalization of TSLA’s free float is in between that of Berkshire Hathaway (BRK-B) and Johnson & Johnson (JNJ), we can expect that TSLA’s index weight will make it the 8^th largest component of SPX with about a 1.35% weight. That implies that index funds will need to buy about $67 billion of TSLA and sell a like amount of the other components on a pro-rated basis. Bear in mind that the stocks that will be sold are current index components, while the stock being purchased will not yet be one.
3. Bear in mind that this will all be occurring on a quarterly expiration. Index funds frequently rebalance on expirations, but this is no ordinary rebalancing. We can expect an unusually large set of market-on-close imbalances. One could assume that the imbalances would see buying of TSLA and selling everything else, but imbalances can often surprise. 
4. Some of the demand for TSLA is likely to be met by the company itself.TSLA has filed to sell $5 billion worth of shares into the market. That is almost certainly a recognition of the index-related demand. It is hardly unprecedented for a company and its insiders to sell shares into an index addition, though it remains to be seen if Mr. Musk and other insiders will join the company itself. That said, even a $5 billion sale could be a drop in the bucket compared to what index funds will require.
5. Where will the rest of the supply of shares come from? TSLA holders are famously faithful, and many of them have been richly rewarded for resisting the opportunity to take substantial profits at various points in the company’s meteoric rise. Yet we have to consider how much of the recent demand from the stock is from speculators who don’t share the long-term love for the stock.TSLA shares are up about 50% since S&P made its announcement, increasing its market capitalization by nearly $200 billion. Remember, the demand is likely to be about $67 billion, and we know that about $5 billion will be met by the company itself. What percentage of that newfound market cap is held by speculators hoping to sell into the demand created by indexers? If that percentage is high, there is a distinct possibility that many could be disappointed. If that percentage is low, with many new converts joining the group of long-term holders, we could see the stock continue to benefit because they, along with index funds, will effectively shrink the amount of stock available to new buyers.
6. A major difference between SPX and the Nasdaq 100 Index (NDX) has been that NDX includes TSLA while SPX does not. The addition of TSLA to SPX will make the two indices even more similar. As of now, the “mega-cap” tech leaders make up about 50% of NDX and about 25% of SPX. With the addition of TSLA, the percentage of SPX will increase.
7. We now have to wonder how TSLA will affect the volatility of SPX. Adding the highly volatile TSLA – with historical volatility ranging from 50-90 – into an index with a historical volatility of 11-17 will almost certainly increase the volatility of SPX. I previously estimated that it would add about ½ – 1% to SPX volatility, with much depending upon how closely TSLA will correlate with SPX. When we consider that VIX is the market’s estimate of the 30-day volatility of SPX, it would not be surprising to see TSLA adding support to VIX.
8. SPX now sports a current P/E of nearly 29 and an estimated P/E of 26 for 2021. The former is a level not seen since 1999. While many believe that it is justified by near-zero interest rates, others see this as a sign of over-valuation. Well, if you think it’s high now, just wait a week.TSLA sports a current P/E of nearly 1,000. Adding TSLA to SPX could push the index’s current P/E to 40 or above! The forward P/E is not likely to be as dramatic, since TSLA’s P/E of “only” 279 will have a more muted effect – somewhere closer to 30 for the index.

Don’t say that I didn’t warn you. I was clear at the outset that there were many layers to consider regarding TSLA’s upcoming inclusion into SPX. I also apologize if I buried the lead since I have to expect that many sharp-eyed macro investors will be startled by the jump in the index’s P/E next week. With a market exposed to this many moving parts, the normally quiet holiday weeks may be punctuated by some fascinating after-effects.