The SP500 is outdated and frankly dangerous.
Square, AirBnB, Zoom, Snap, Roku, Moderna, Zillow, Docusign, Teladoc, … the list goes on for the number of market leading mega/large cap stocks not included in the SP500. What is the criteria to get in the 500? More importantly what is the criteria for expulsion? The SP500 use to be tough to beat. Now everyone is doing it. And, here is why.
Let’s start off with the criteria to enter into the SP500 especially this one: Positive reported earnings in four most recent quarters. During a time when driving down costs and taxing “angel” investors to do so, thereby going deeper and deeper into debt in hopes of beating out market competition and being the only big player in a specific industry is the default plan. As well as a time of seemingly near perfect information regarding market activity through social media, news, and search engines that give investors more confidence to bet big on ever younger companies to win most of there market share. We are at a place where companies like the ones mentioned above in the first line are trading at valuations that only make sense when looking at the market impact of there technology, social influence, and user base. But, do not make any sense purely looking at the financials and fundamental analysis. So will these market leading winners who are the favorites to win there respective industry ever be included in the SP500 as they debt finance there meteoric rise? The answer is not until they’ve already won and the big stock market gains are far in the past.
Combine this phenomena with seemingly no real methodology for exclusion from the SP500 other than making space for those rare newcomers. We have the makings of an outdated fatty index that is slow and unable to keep up with it’s lean, mean, and green baby brother the Nasdaq 100, or any decent USA consumer discretionary index tracker as well. See, gains from the SP500 are slow, in part because the barriers to prevent companies from entering and protect the ones inside make it so. There was a time when those barriers protected the 500 from the often questionable outer markets. But, now the tides are turning as investors are more knowledgeable to decide which companies they think are going to be winners in the market.
“400 crappy companies plus 100”. This moniker recently floating around is not as indefensible as some may believe. The SP500 has always had issues. There is built in infighting meaning that many companies in the 500 are directly competing with others in the same index. Also, as companies age as well as there market cap grows the capacity to grow even further becomes harder especially as they reach closer to the edges of there market influence. And, as the greater market ebbs and flows all companies are subject to market forces that can and has even bankrupted companies in this historically respected index. Bankruptcy scare aside don’t forget the number of companies that were forced to take large government loans to stay alive.
Combine all that: The outdated barriers to entry and exit. The rise of companies exercising debt and leveraging technology to propel themselves further in there industry while attracting investment that pushes there market cap into the upper echelons of the tech industry. You have a recipe for an outdated, slow, and oversized value index holding 400 value companies plus 100 that are beating down on those other 400.
