The Dow is shaking up the index and the S&P 500 might not be far behind. The big news lately is all the changes to the Dow Jones Industrial Average and possible changes to the S&P 500 index. The main culprits causing headaches for the indexes are Apple & Tesla.
The indexes have a set of criteria and eligibility to receive membership in these historical indexes. Many companies take great pride in being included! I will work to address what is shaking up the indexes and how it might affect your investment plan.
Dow Jones Industrial Average
Back in 1896, a man named Charles Dow created the famous Dow Jones Industrial Average (DJIA) that comprised of just twelve stocks, all of them being industrials. Fast forward to 2020; the Dow is probably the second most followed and well-known indexes behind the S&P 500. It is comprised of 30 companies that come from a variety of sectors, unlike the original list of just industrials.
Changes to the index are usually very gradual and allowed to evolve without shocking the market. It took 32 years for the index to grow from 12 to 30 companies! Since 1896 the index has only changed 60 times, which averages out to about every two years.
The most recent announcement was a shock and colossal shake up! The Dow was going to be significantly impacted by Apple’s(APPL) decision to split its stock. The Dow is a price-weighted index rather than cap-weighted like the S&P500. Thus Apple’s stock split significantly reduces its relevance in the Dow.
As you can see from the chart above, Apple has the ability to drive the Dow, which it has in 2020. Check out this chart of Apple vs. the S&P. With Apple pulling significant weight, it can help lift the index performance. Without Apple, in the driver’s seat, there are concerns that the Dow will underperform indexes and lose favor.
With significant concerns comes a big change! If Apple will not be the driver, the leadership of the Dow index decided to add:
Which means three have to be removed:
This change will take effect 8/31 the same day as the Apple Split. The changes will not impact the level of the index but could hurt the overall performance. Exxon was probably the most upset as it had been part of the index since 1928, and Raytheon is not that far behind with membership dating back to 1939.
Even though membership to an index should not affect the market price, it can affect market sediment, which we saw with CRM, AMGN, and HON seeing a boost and XOM, PFE, RTN falling some.
S&P 500 Index – Possible change
The S&P500 index is the king of all index funds, and well, just like the Dow, it is in a position that may require a change. As I mentioned at the beginning of this post that Tesla (TSLA) is creating problems as it has actually met all the criteria for the S&P500 Index.
The issue that had kept Tesla out for the longest time was that it was not profitable for four straight quarters. Now that it has made money, the Index committee is in a bind as Tesla’s market cap has surpassed Walmart, and the index is supposed to track the largest 500 companies.
Two main issues are holding up membership. To add Tesla, it would require a short term selloff of equities to fund the new Tesla stake, which would represent about 1% of the index. The more complicated question is that Tesla’s core business is not the most valuable part. Its profits are being made from selling regulatory credits to other car manufactures to comply with green initiatives.
If auto manufacturers expand into electric cars and no longer need credits from Tesla, its ability to drive a profit would be significantly reduced. This is the primary concern!
Should Tesla be added to the index? Let me know in the comments below.
This post is my opinion, which is strictly for information & educational purposes only. The post is not intended to provide any investment advice. Please seek your own duly licensed professional for investment advice as they will be able to consider your situation. Please read my Terms & Conditions Page for a full disclaimer.