For investors with exposure to the US Stock market, portfolios will be affected by the recent changes to the S&P 500 Index announced by David Blitzer, chairman and managing director at S&P Dow Jones Indices. Due to the enormous size of market capitalization (total dollar market value of a company’s outstanding shares) by Apple, Amazon, Facebook, and Alphabet (better known as Google), the technology sector of the S&P 500 is overwhelming the index, which significantly skews its results. These four stocks alone have a market cap in excess of $3.3 trillion.
Currently, the technology sector represents approximately 27% of the total S&P 500 index, producing more than half of the S&P 500’s gain for 2018. To better reflect the underlying companies that comprise the sector, several changes will occur after the close of business on September 28. With the technology sector dominated by just four companies, the sector was thought to be too unwieldy.
To reduce the size of the technology sector, Amazon and eBay will move to the consumer discretion sector. The rationale for this shift is that eBay and Amazon primarily sell discretionary consumer items (although that decision seems debatable, as most of Amazon’s profits come from its cloud services.)
An additional change to reduce the size of the technology sector and better reflect its impact, is the introduction of a new sector dedicated to communication-related companies. The former telecommunications sector will be renamed. Facebook and Alphabet will move to the newly-named communication services sector, along with game-makers Take Two Imaginative Software, Electronic Arts and Activision Blizzard. Furthermore, the giants Walt Disney Company, Netflix and Comcast will be included in this sector. The description of the new sector is telecommunications, media and entertainment.
What is the significance of these changes? If you are a mutual fund or an Exchange-Traded Fund (ETF – similar to an index fund) mimicking the technology sector or telecommunications sector of the S&P 500, there will be a temporary surge in trading come October 1st. Individuals owning such shares in their taxable accounts may experience large capital gains as the indices buy and sell securities to match the new sector changes. It should raise the profits of some brokerage and custodial firms. Related to the added transactions, it may increase volatility for a short period of time too. But overall, it will have little effect. Outside of the surge in trading and temporary recognition of gains and losses from these trades, we do not foresee much of a long term impact to you.
One of the benefits of Colman Knight Investment philosophy is that, while this is interesting news, very few, most likely none, of your holdings will be impacted by these changes. Our policy is not to own those types of sector investments and as a result, you can relax as others panic.