June 16, 2024

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The big changes in the S&P 500 on Friday highlight the strength of the index providers

The big changes in the S&P 500 on Friday highlight the strength of the index providers

Index gurus are at it again. Some of the most popular stocks are rerating on Friday, and that means a lot of money will be moving around.

Ever wonder why Walmart is classified as a consumer staple stock in the S&P 500, but similar retailers like Target, Dollar General, and Dollar Tree are classified as consumer discretionary stocks? Many people also wondered.

Friday, that will change.

Target, Dollar General, and Dollar Tree will move out of the consumer discretionary corner of the stock market, joining Walmart as core consumer businesses.

food consumption will increase; Consumer discretion is going to get a little smaller.

Ever wonder why Visa, Mastercard, and Paypal, which look like financials, are actually listed as technology stocks instead?

Other people have asked about it as well.

On Friday, that will change, too.

Visa, Mastercard, and Paypal, along with a few other names, will be moved into the financial sector.

As a result, the technology will be a little smaller, and the financial one a little more.

Indexing Victory: Where the stocks are placed

Thirty years ago, this would all have interested academics, but almost no one else would.

That was before the triumph of indexing and exchange-traded funds.

Today, there is $6 trillion directly indexed to the S&P 500 index alone, which is the largest of all indices in terms of the amount of money attached to it. There are trillions more indirectly indexed. That is, many funds are using the S&P as a ghost and trying to match their returns without paying Standard & Poor’s licensing fees.

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Regardless: $6 trillion is a lot of money. It represents about 18% of the total market capitalization of the S&P 500.

And that’s just the S&P 500. There are thousands of indices that slice and slice the stock and bond market in endless ways.

Exchange-traded funds (ETFs), which started 30 years ago, allow investors to buy these indices in a low-cost, tax-advantaged wrapper that can be traded on a daily basis. The ETF business in the US alone is worth about $7 trillion, most of which is in passive (indexed) funds.

The people who issue these ETFs (BlackRock, Vanguard, State Street, Schwab, and a few others), for the most part, don’t own the indexes behind the ETFs. They license those indexes from the index providers. The largest are Standard & Poor’s, MSCI and FTSE Russell (owned by the London Stock Exchange Group).

And the people who manage what goes in and out of those indexes are now very influential.

How does the inventory grading system work?

Have you ever wondered why we use weird phrases like “consumer discretion” and “communication services” to describe different parts of the stock market?

You can thank S&P and MSCI.

In 1999, in an effort to standardize how stocks are rated, MSCI and Standard & Poor’s created an industry standard called the Global Industry Classification Standard (GICS).

All major public companies are divided into 11 sectors, 24 industry groups, 69 industries and 158 sub-industries. Weighting in the most important index, the S&P 500, is determined by market capitalization.

Here’s the current sector weighting in the S&P 500:

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Sectors in the S&P 500

  • Technology 27%
  • health care 14%
  • Finance 12%
  • consumer appreciation 11%
  • industries 9%
  • Communication services 8%
  • consumer goods 7%
  • 5% energy
  • Utilities 3%
  • REITs 3%
  • material 2%

Source: FactSet

Every March, S&P and MSCI announce changes to their rating system. this year, Changes that started last year On March 17th.

Among the shifts notable this year, an entire tech sub-industry called “Data, Processing, and Outsourcing Services,” including Mastercard, Visa, and Paypal, is moving into financials and will now be called “Transaction Processing and Services.”

Separately, S&P and MSCI understand that Target, Dollar General, and Dollar Tree all sell similar items to WalMart, so they’re all under the same basic consumer goods umbrella.

What does that mean for investors?

If you’re an investor in a widely diversified total market index fund like the S&P 500, the changes won’t make much difference for you.

The changes will be more significant if you are trading in sectors, which is an increasingly popular strategy. Just look at all the money trading in bank stocks this week, a lot of which went through the SPDR S&P Bank ETF. (KBE) or SPDR S&P Regional Banking ETF (KRE).

Moving Target, Dollar General, and Dollar Tree to consumer staples from consumer estimation will increase the weighting (and change the future performance) of consumer staples, and reduce the weighting (and change the future performance) of consumer estimation.

Likewise with finance and technology: Mastercard, Visa and Paypal will enter into financial statements, which will increase the weight (and change the future performance) of financial statements, and reduce the importance of technology.

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Net effect: S&P’s technology weighting will decrease from about 27.7% to 24.5%, while financial data weighting will increase from 11.5% to 14.2%.

The key is to make sure these indicators are relevant. Dan Draper, CEO of S&P Dow Jones Indices, at S&P Global, in a recent interview on CNBC’s ETF Edge. “Do they reflect changes in consumer demand or changes in market structure?”

Here’s another thing it reflects: The people who decide what goes into these catalogs are becoming very influential. They’re not money managers, they’re index providers, but don’t let that fool you: in a world where people buy index-related money, the people who determine what goes into those indexes are already very powerful.