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Market Further: Tesla, becoming a member of the S&P 500, is the mom of all inventory market occasions

Wall Street will soon find out when investors embark on a potentially fast-paced stock round thanks to electric vehicle maker Tesla.

On December 18, Tesla's proposed inclusion in the grandfather of US benchmark indices will create what Howard Silverblatt, senior index analyst for S&P Dow Jones indices, MarketWatch called the "mother of all" equity market realignment events. An event that will change the topography of the S&P 500 at a crucial point in an already turbulent time in the financial markets.

On Friday, S&P Dow Jones Indices announced that real estate investments trust Apartment Investment Management Co.
AIV,
-0.49%,
would be removed from the 500-stock index to make way for the $ 578 billion electric car pioneer. With CEO Elon Musk owning roughly 20% of the company's shares, the value will be closer to $ 460 billion.

Part of the concern on Wall Street is that Tesla, the largest of its kind by market value joining the S&P 500, will immediately see a weight in the 500 company index between 1.5% and 1.6% .

To put that addition in perspective, every $ 11 step by the Palo Alto, California-based company would swing the entire S&P 500 nearly a point accordingly.

"We have never included anything that big in the index," said Silverblatt.

The realignment of the S&P 500 last quarter saw a sizeable $ 32.4 billion in switches, which was above the $ 27 billion average and below the record high of $ 50.8 billion in the third quarter of 2018.

With the realignment next Friday, trading could be well over $ 100 billion, with much of it on the sell side as passive investors and index trackers who hold the same securities as the index and have to make room in the same ratio. to add Tesla.

There is roughly $ 5.3 trillion in funds compared to the S&P 500, including funds from Vanguard, which oversees the Vanguard S&P 500 ETF
VOO,
-0.13%,
and State Street, which runs the SPDR S&P 500 Trust
SPY,
-0.12%,
commonly referred to as SPY on Wall Street.

“I think Tesla is a highly liquid stock on a normal trading day, but there will be forced buying as SPY, IVV, VOO, and the various mutual funds of the S&P 500 index take about 1.5% of the assets into the stock and more moderate Todd Rosenbluth, head of ETF and mutual fund research at CFRA, told MarketWatch, pointing to the ticker symbols of some of the large exchange-traded funds that Tesla is a part of.

“Although more than a dozen companies are added to the S&P 500 index each year, they are typically among the smallest companies, making up less than 0.1% of the index. Tesla is significantly larger and requires more planning on the part of asset managers who don't want to take too much index tracking risk, ”said the CFRA researcher.

"It's definitely big," Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, told MarketWatch on Wednesday.

In addition to the SPY, the State Street complex has four other key funds that will be adapted to Tesla: the SPDR Portfolio S&P 500 Growth ETF
SPYG,
+ 0.06%,
the SPDR portfolio S & P 1500 Composite Stock
SPYG,
+ 0.06%,
the Consumer Discretionary Select SPDR Fund
XLY,
-0.48%
and State Street & # 39; s lower-cost version of SPY, the SPDR Portfolio S&P 500 ETF
SPYG,
+ 0.06%.

Overall, Bartolini estimates State Street would have to trade around $ 6 billion to include Tesla in these funds, with most of that coming from SPY.

"It's the biggest SPY ever to be rebalanced," the State Street official said, noting that the fund manager thinks it is well equipped to deal with it.

And it's not just passive funds that will be forced to buy Tesla. Goldman Sachs, in a research note last month, estimated that actively managed funds, compared to the S&P 500, would acquire approximately $ 8 billion of the company's stock.

Silverblatt said the fact that December 18 also marks four times the witch – the simultaneous expiry of stock index futures and options and individual stock futures and options, a particularly volatile period in trading – could actually help reliving market pressures as this session is usually a high liquidity day that could ease the turmoil related to Tesla moves. Tesla shares will be traded on the SPX on December 21st.

Still, there are questions about what the inclusion of Tesla will mean in the longer term. Bartolini estimated that the inclusion of Tesla could increase the price-to-earnings ratio of the S&P 500, a measure of measuring stock value, by more than 1.6%. Tesla's P / E over the past 12 months is 1,208 and the S & P500's trailing 12-month P / E is 27.08 according to FactSet data.

To make matters worse, Tesla is an unusually volatile stock even for an S&P 500 member. Stocks are up 48% since the S&P Dow Jones Indices announced they would be added to the broad-market index in mid-November. Tesla's shares are up a whopping 622% this year and are considered one of the most volatile stocks among big companies.

Bartolini notes that, according to some metrics, Tesla is far more volatile than companies like Apple or even the SPY itself when it comes to daily returns.

That being said, he doesn't expect Tesla's volatility to add to the overall volatility of the S&P 500.

“If a fund only held AAPL, TLSA, and Wells Fargo – all stocks that have had higher volatility than the market over the past year – the volatility of that portfolio would not be the weighted average of the standard deviations. The correlation in returns between these stocks is taken into account, ”the State Street official explained.

Tesla historically had a positive correlation with the S&P 500 of 0.49 on a scale where 1.00 means perfect direct correlation and -1.00 means perfect indirect correlation, Bartolini estimated.

According to Biriyini Associates Inc., the average correlation for an index component since 2015 based on a continuous 100-day correlation with the index was 0.53 in data commissioned by MarketWatch.

Biriyini's research director Jeff Rubin told MarketWatch that Tesla's correlation based on this metric was 0.39 and was troubled during that period, with stocks showing their correlation with the S&P 500 during the pandemic-inspired sell-off tightened from February to March.

Source: Birinyi Associates

Bartolini also made another point that Tesla's inclusion will have a significant impact not only on passive investments, but also on active money managers who have previously relied on Tesla for something called alpha, or returns above a benchmark. Now that Tesla will be part of the S&P 500, it could challenge hedge funds and other investors to find different ways to beat the market.

"It's game over now," said the State Street official. "I think this will be a high-flying growth (funds) challenge to derive alpha," he said.

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