{"id":69561,"date":"2020-12-16T13:46:00","date_gmt":"2020-12-16T18:46:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=69561"},"modified":"2023-02-10T13:33:30","modified_gmt":"2023-02-10T18:33:30","slug":"what-to-expect-when-youre-expecting-tesla-to-join-the-sp-500","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/stocks\/what-to-expect-when-youre-expecting-tesla-to-join-the-sp-500\/","title":{"rendered":"What to Expect When You\u2019re Expecting Tesla to Join the S&#038;P 500"},"content":{"rendered":"\n<p>By this point, anyone reading this piece should be well aware that Tesla (TSLA) will be joining the S&amp;P 500 Index (SPX) effective December 21<sup>st<\/sup>.&nbsp;&nbsp; In practical terms, that means that index funds will need to own the stock as of the close of this Friday, December 18<sup>th<\/sup>.&nbsp; Ever since S&amp;P\/Dow Jones Indices announced this unprecedentedly large index addition on November 16<sup>th<\/sup>, I have discussed the topic both in this space and in various media outlets.&nbsp; In one case, I described it as \u201c<a href=\"https:\/\/finance.yahoo.com\/video\/tesla-stocks-many-layers-peeling-152733155.html\">peeling the onion<\/a>\u201d because this one index addition could have a wide range of repercussions.&nbsp; I will attempt to outline some of them below.<\/p>\n\n\n\n<ol class=\"wp-block-list\" type=\"1\"><li>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.\u00a0 An ideal situation for indexers occurs when one company is acquired for cash and is replaced by a company of similar size.\u00a0 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.\u00a0 In this case, TSLA is replacing Apartment Investment &amp; Management (AIV), which recently spun-off Apartment Income REIT (AIRC).\u00a0 The combination of AIV and AIRC are worth just over $6bn.\u00a0 TSLA is about $580 billion larger!<\/li><li>Besides requiring sales of AIV\/AIRC, the addition of TSLA will require massive selling in the other 498 stocks in SPX.\u00a0 At any given time, an index fund has a fixed amount of investable assets.\u00a0 Those assets need to be balanced to properly represent the index composition.\u00a0 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.\u00a0 It is estimated that there is $5 trillion explicitly indexed to SPX.\u00a0 Since the market capitalization of TSLA\u2019s free float is in between that of Berkshire Hathaway (BRK.B) and Johnson &amp; Johnson (JNJ), we can expect that TSLA\u2019s index weight will make it the 8<sup>th<\/sup> largest component of SPX with about a 1.35% weight.\u00a0 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.\u00a0 Bear in mind that the stocks that will be sold are current index components, while the stock being purchased will not yet be one.<\/li><li>Bear in mind that this will all be occurring on a quarterly expiration.\u00a0 Index funds frequently rebalance on expirations, but this is no ordinary rebalancing.\u00a0 We can expect an unusually large set of market-on-close imbalances.\u00a0 One could assume that the imbalances would see buying of TSLA and selling everything else, but imbalances can often surprise.\u00a0<\/li><li>Where will the rest of the supply of shares come from?\u00a0 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\u2019s meteoric rise.\u00a0 Yet we have to consider how much of the recent demand from the stock is from speculators who don\u2019t share the long term love for the stock.\u00a0 TSLA shares are up about 50% since S&amp;P made its announcement, increasing its market capitalization by nearly $200 billion.\u00a0 Remember, the demand is likely to be about $67 billion, and we know that about $5 billion will be met by the company itself.\u00a0 What percentage of that newfound market cap is held by speculators hoping to sell into the demand created by indexers?\u00a0 If that percentage is high, there is a distinct possibility that many could be disappointed.\u00a0 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.<\/li><li>A major difference between SPX and the NASDAQ 100 Index (NDX) has been that NDX includes TSLA while SPX does not.\u00a0 The addition of TSLA to SPX will make the two indices even more similar.\u00a0 As of now, the \u201cmega cap\u201d tech leaders make up about 50% of NDX and about 25% of SPX.\u00a0 With the addition of TSLA, the percentage of SPX will increase.<\/li><li>We now have to wonder how TSLA will affect the volatility of SPX.\u00a0 Adding the highly volatile TSLA \u2013 with historical volatility ranging from 50-90 \u2013 into an index with a historical volatility of 11-17 will almost certainly increase the volatility of SPX.\u00a0 I previously estimated that it would add about \u00bd &#8211; 1% to SPX volatility, with much depending upon how closely TSLA will correlate with SPX.\u00a0 When we consider that VIX is the market\u2019s estimate of the 30 day volatility of SPX, it would not be surprising to see TSLA adding support to VIX.<\/li><li>SPX now sports a current P\/E of nearly 29, and an estimated P\/E of 26 for 2021.\u00a0 The former is a level not seen since 1999.\u00a0 While many believe that it is justified by near-zero interest rates, others see this as a sign of over-valuation.\u00a0 Well, if you think it\u2019s high now, just wait a week.\u00a0 TSLA sports a current P\/E of nearly 1,000.\u00a0\u00a0 Adding TSLA to SPX could push the index\u2019 current P\/E to 40 or above!\u00a0 The forward P\/E is not likely to be as dramatic, since TSLA\u2019s P\/E of \u201conly\u201d 279 will have a more muted effect \u2013 somewhere closer to 30 for the index.<\/li><\/ol>\n\n\n\n<p>Don\u2019t say that I didn\u2019t warn you.&nbsp; I was clear at the outset that there were many layers to consider regarding TSLA\u2019s upcoming inclusion into SPX. &nbsp;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\u2019s P\/E next week.&nbsp; With a market exposed to this many moving parts, the normally quiet holiday weeks may be punctuated by some fascinating after-effects.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>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. <\/p>\n","protected":false},"author":4,"featured_media":68511,"comment_status":"closed","ping_status":"open","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[17,14700,6,8,9,22,26,3],"tags":[910,161],"contributors-categories":[13576],"class_list":{"0":"post-69561","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-futures","8":"category-ibkr-market-insights","9":"category-north-america","10":"category-region","11":"category-securities","12":"category-stocks","13":"category-text-articles","14":"category-traders-insight","15":"tag-sp-500","16":"tag-tesla","17":"contributors-categories-interactive-brokers"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v26.9 (Yoast SEO v27.5) - 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He has held numerous roles in the organization since joining Timber Hill, IBKR\u2019s predecessor, in 1995 as Equity Risk Manager and an options market maker. He developed and implemented automated trading strategies for stocks and options before moving into his current role. Steve has guest authored several columns in Barron\u2019s and made numerous live on Bloomberg TV and Radio, CNBC, Yahoo Finance, Fox Business, and several other media outlets in North America, Asia, Australia, and the Middle East in addition to being quoted frequently in print and electronic media. Prior to joining Interactive Brokers, Sosnick held senior trading roles at Morgan Stanley, Lehman Brothers, and Salomon Brothers, where he completed the firm\u2019s famed training program.","sameAs":["https:\/\/ibkr.com"],"url":"https:\/\/www.interactivebrokers.com\/campus\/author\/steve-sosnick\/"}]}},"jetpack_featured_media_url":"https:\/\/www.interactivebrokers.com\/campus\/wp-content\/uploads\/sites\/2\/2020\/12\/shutterstock_618674669.jpg","_links":{"self":[{"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/posts\/69561","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/comments?post=69561"}],"version-history":[{"count":0,"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/posts\/69561\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/media\/68511"}],"wp:attachment":[{"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/media?parent=69561"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/categories?post=69561"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/tags?post=69561"},{"taxonomy":"contributors-categories","embeddable":true,"href":"https:\/\/ibkrcampus.com\/campus\/wp-json\/wp\/v2\/contributors-categories?post=69561"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}