Client Portals

Week 32: Quirks of the S&P 500 & The Power Behind Meme Stock Upside3 min read

Aug 11, 2021 - Max Osbon ( 5 mins to read)

Briefing: The S&P500 is the biggest brand name in the investment world. It’s known as the index that passively tracks the 500 largest public US companies, but that’s not 100% true and the list of exceptions is growing. The very late addition of Tesla in December of last year is a prime example. | The options market is the driving force behind the unusual performance in “meme stocks.”

Noticeable Missing Names In The S&P 500

Square was in the news last week for acquiring AfterPay, an Australian leader in the ‘buy now, pay later’ space. Square is also known for CashApp, the payment terminals that you see at coffee shops and small businesses, and for generally being a classic Silicon Valley leader in the digital finance revolution. Square now has a market cap of $120B, making it one of the top 100 largest public US companies, but it is not in the S&P 500.

The S&P 500 is known for tracking the largest 500 stocks in the US by market cap, but that’s not exactly true. Rather than being a rules-based index, the list of companies is maintained by a special and fairly secretive committee at the S&P Dow Jones Indices company.

Tesla was added to the S&P 500 in December last year at a staggering $640B valuation, which was probably about 5 years too late. S&P 500 investors missed at least a 10x Tesla return over that period of time.

The S&P 500 investment committee tends to follow a profitability rule. It’s less of a rule and more of a guideline. It may seem like a reasonable idea to only invest in profitable companies, but it’s not really how the world works in 2021. Silicon Valley leaders realized early on that, due to power laws, it’s more important to capture entire markets and figure out the profitability later. Google, Facebook and Amazon are perfect examples of grow first, find profitability later. They are each worth more than $1T today.

Today there are a number of leading US companies that are not in the S&P 500 but are large enough where you might assume them to be. Leading innovative companies like Docusign, AirBnB, Cloudflare, Twilio, Snapchat and Zoom don’t meet specific eligibility criteria today. However, they are following the same strategy as nearly all of the tech leaders before them: grow first to capture the market, find profitability later.

Another slight inconsistency is that not all S&P500 companies are US-only. 22 of them are not headquartered in the US and the strong majority have fully global operations. NXP Semiconductor, which was added this year, was founded in the Netherlands and is still headquartered there.

There’s nothing wrong with the S&P500. It’s important for investors to know what they own. We do feel that the S&P 500 investment committee is being overly conservative by not including today’s leading growth companies despite fulfilling the size requirement. Investors may want to supplement their portfolios by owning some of these leading growth companies before they are included in the S&P and before they reach maturity.

Retail traders are using options to move stock prices

Bloomberg columnist Matt Levine had a great column about this recently. When a broker sells you a call option, they also buy the underlying stock to hedge their exposure. This can quickly become a feedback loop. Robinhood IPO’d last week at $30B and was flat on the first day of trading. When options became available on Robinhood stock, the stock quickly doubled. The options volume was very high, meaning the brokers had to buy a lot of Robinhood stock to hedge, driving up the price dramatically. This market phenomenon is nowhere close to over and it’s turning many “normal” large companies into Reddit frenzied “meme-stocks”. Two weeks ago it was AMD (semiconductors), followed by Moderna which is up 60% over the last month.

The takeaway is: most of this market manipulation is driving prices up, this is not going away and pretty much any company today can become a meme-stock overnight so long as they have an options market.

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