Aficionados of Tesla Inc. were celebrating last week as the electric-car maker was accepted into the S&P 500, propelling its shares up 22% in two days.
Step back from the extraordinary gains, and the fact that America’s seventh-biggest company by market value is only now to be admitted to the index of the country’s 500 most-valuable stocks is weird. But it is only the most obvious of many strange but stock-price-moving ways that indexes rumble markets. Indexes play two important but often conflicting roles: They measure broad market performance, and they are investment tools.
Start with Tesla. It will join the S&P 500 next month after a decision by the committee that oversees the index. The same committee had rejected the company in September even after it finally met the index’s qualification condition of being profitable for 12 months.
Index membership really matters, because there is about $11 trillion indexed or benchmarked to the S&P. Passive funds will have to buy tens of billions of dollars of Tesla stock—hence, the big move in price. So much money will need to move when the index is reconstituted next month that S&P is consulting on adding the car maker in two chunks.
Again, for both the passive investor and those using the index as a gauge of market performance, this is strange. Why do companies have to be profitable before they are allowed into the index? The whole point of investing passively is to leave it up to other people to decide if a company earns enough to justify its stock price. A gauge of performance should measure the profitable and the loss-makers alike. Plenty of companies are loss-making after they join the index, especially this year; it is odd that once in the club, the condition no longer applies.