The index gurus are back. Some of the best-known stocks are reclassified on Friday, which means a lot of money will move.
Have you ever wondered why Walmart is ranked as a consumer staple stock in the S&P 500, but similar retailers such as Target, Dollar General and Dollar Tree are ranked as consumer discretionary stocks? Many other people have also asked the question.
Friday will change.
Target, Dollar General and Dollar Tree will leave the consumer discretionary sector of the stock market and join Walmart as consumer staples companies.
Basic consumer goods will grow; consumer discretionary will become a bit smaller.
Have you ever wondered why Visa, Mastercard, and Paypal, which appear to be financial stocks, are actually listed as tech stocks instead?
Other people have also asked the question.
On Friday, that too will change.
Visa, Mastercard and Paypal, as well as a few other names, will be transferred to the financial sector.
As a result, the technology will be a little smaller, the finances a little bigger.
The triumph of indexing: where a title is placed matters
Thirty years ago, all of this would have interested academics, but hardly anyone else.
This was before the triumph of indexing and exchange-traded funds.
Today there is $6 trillion directly pegged to the S&P 500, the largest of all indexes in terms of the amount of money tied to it. There are trillions more that are indirectly indexed. In other words, many funds use the S&P as a bogey and try to match their returns without paying license fees to Standard & Poor’s.
Anyway: $6 trillion is a lot of money. That’s 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 dice the stock and bond market endlessly.
Exchange-traded funds (ETFs), which originated 30 years ago, allow investors to buy these indices in a low-cost, tax-advantaged package that can be traded on an intraday basis. ETF activity in the US is around $7 trillion, most of it in passive (index-linked) funds.
The people who issue these ETFs (BlackRock, Vanguard, State Street, Schwab and a handful of others), for the most part, don’t own the indices behind the ETFs. They license these indexes from index providers. The biggest are Standard & Poor’s, MSCI and FTSE Russell (part of the London Stock Exchange Group).
And the people who manage what goes in and out of those indexes have now become very influential.
How the Inventory Classification System Works
Have you ever wondered why we use weird terms like “consumer discretionary” and “communications services” to describe different parts of the stock market?
You can thank S&P and MSCI.
In 1999, in an effort to standardize stock classification, MSCI and Standard & Poor’s introduced an industry benchmark called the Global Industry Classification Standard (GICS).
All major public enterprises are divided into 11 sectors, 24 industry groups, 69 industries and 158 sub-industries. Weighting in the largest index, the S&P 500, is determined by market capitalization.
Here is the current sector weighting in the S&P 500:
S&P 500 sectors
- Technology 27%
- Health care 14%
- Finance 12%
- Consumer Discretionary 11%
- Industrial 9%
- Communication services 8%
- Basic consumption 7%
- Energy 5%
- Utilities 3%
- REITs 3%
- Materials 2%
Each March, S&P and MSCI announce changes to the classification system. This year, the changes initiated last year will take place on March 17.
Among the notable changes this year, an entire sub-industry of technology, called “data and processing and outsourced services”, and including Mastercard, Visa and Paypal, is moving to financial services and will now be called “transaction and payment processing services”. services”.
Separately, S&P and MSCI recognize that Target, Dollar General and Dollar Tree all sell similar merchandise to WalMart, so they all fall under the same basic consumer umbrella.
What does this mean for investors?
If you’re an investor in a broadly diversified global market index fund like the S&P 500, the changes will make little difference to you.
The changes will be greater if you trade sectors, which is an increasingly popular strategy. Just look at all the money that has moved into bank stocks this week, much of which has gone 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 in Consumer Discretionary will increase the weighting (and change future performance) in Consumer Staples and reduce the weighting (and change future performance) in Consumer Staples discretionary.
The same with financials and technology: Mastercard, Visa and Paypal will go into financials, which will increase the weighting (and change future performance) of financials, and decrease the weighting of technology.
The net effect: the weight of technology in the S&P will drop from around 27.7% to 24.5%, while the weight of financials will drop from 11.5% to 14.2%.
“The key is to make sure those clues are relevant,” Dan Draper, CEO of S&P Dow Jones Indices, at S&P Global, said in a recent interview on CNBC’s ETF Edge. “Do they reflect changes in consumer demand or changes in market structure?
Here’s something else it reflects: the people who decide what goes into these indexes have become very influential. They’re not fund managers, they’re index providers, but make no mistake: in a world where people buy index-linked funds, the people who determine what goes into those indexes have become very powerful.