Comment by tristanj
17 hours ago
On a fundamental level, the S&P 500 index is meant to be a benchmark of the market. Journalists, policymakers, investment managers, politicians, regular investors, everyone I know all use the S&P 500 as the benchmark of the US stock market.
If a significant percentage of the market is excluded from the index because they don't meet index inclusion criteria, then then index stops being a useful benchmark.
S&P500 is not a total market index. It tracks a specific kind of large firm, with certain filters.
Fast tracking means that the market likely wont have enough time to find the settled price (especially with the knowledge that passive funds are about to buy), and including a mispriced thing does not necessarily make the benchmark more accurate.
Those filters for S&P 500 inclusion criteria have changed many times. They are not sacred nor set in stone. The question is, do those filters, which were designed for GAAP profitable traditional companies & discriminate against fast growing cash-flow-reinvesting startups that prioritize growth over profit, unnecessarily exclude major players in the U.S. stock market? The S&P inclusion criteria reward companies that prioritize profit over growth.
SpaceX, Anthropic, and OpenAI are all giga-caps preparing to IPO, and none of them will be eligible for S&P inclusion because of the 12-month profitability requirement. At current valuations, all are part of the top 20 largest companies in the US. These companies may be excluded from the S&P500 for potentially years, until they reach 12 months of profitability.
And you are vastly overstating the effect of S&P500 fast track inclusion, the plan was to reduce it from 12 months to 6 months; which is more than enough time for the market to find a price.
> Under current rules, these fast-growing companies would be excluded from the S&P500 for potentially years, until they reach 12 months of profitability.
> And you are vastly overstating the effect of S&P500 fast tracking, the plan was to reduce it from 12 months to 6 months; which is more than enough time for the market to find a price.
They might never reach 6 months of profitability, let alone 12 months.
> which is more than enough time for the market to find a price
The price markets find would still inevitably be influence by the knowledge that the demand would increase massively in a few months.
> inclusion criteria reward companies that prioritize profit over growth
Or stable and sustainable growth. Whatever else SpaceX, OpenAI, Anthropic valuations are price in extremely optimistic growth. But yeah, I do see a point that including adequately priced growth stocks could be a net benefit but of course accouting for the actual valuation would turn index funds into managed ones.
Thankfully its not an issue at all since there is Nasdaq 100.
My mistake: it was Nasdaq that is being reduced to days, not S&P. Thanks.
Thank absolute Christ none of the companies you just listed will enter SP500 by default. The Risk/Reward is not functionally there to fast track companies and all of the examples you listed are too big to keep coasting on venture capital. Let them be public for 6+ months and let's see where they are at in the eyes of the public markers and then their inclusion can be re-evaluated.
What's the downside for the average pension holder with a 30 year horizon if they miss 6 months of Elon's newest scheme?
> If a significant percentage of the market is excluded from the index because they don't meet index inclusion criteria, then then index stops being a useful benchmark.
So what's the reason for fast entry specifically? If it's a significant portion of the market and will remain so, it doesn't need an accelerated entry. A benchmark should be conservative about new entrants so that it doesn't turn from a market benchmark to a trend/fad benchmark.
If time validates the valuations the entry will come in time, just like for previous entries.
> So what's the reason for fast entry specifically?
Inclusion in as many indexes as possible is basically the definition of "too big to fail." It's the ultimate de-risk to know that if you fuck up badly enough the government will just give you everyone's money.
Has anyone made sure Elon wasn’t born on Jekyll Island
Because the index needs accuracy. If a company is 1-2% of the total US market cap and not included in the index, then the index is wrong right now. The longer this company is not in the index, the longer this error compounds.
In the coming few months, multiple giga-cap companies (SpaceX, OpenAI, Anthropic) are all planning to IPO. These companies will likely never meet S&P profitability inclusion criteria for the next 5 years. These are not bad companies, but because the S&P inclusion criteria were written for old GAAP profitable companies, and not high-growth companies that invest their cashflow into company growth over profits. Excluding some of the most civilization changing companies from the benchmark means the benchmark is doing a terrible job.
"Because the index needs accuracy.", and I would argue that include price accuracy not just inclusion accuracy. The S&P is a benchmark that is designed to reflect a subset of the market, and giving only some companies early access to the benchmark changes the benchmark. So if you want a benchmark that's designed to include all the big stocks regardless of age, profitability, etc then go make a new benchmark. The only thing you need to do is convince others to use your benchmark.
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There are indexes which explicitly try to capture the entire market- the Russell 3000 is most prominent, but the Wiltshire 5000 is another one, and Vanguard's Total Market Funds and ETF follow the CRSP US Total Market Index. I believe all of them plan to include SpaceX/OpenAI etc. within a few weeks of its listing, which is what I'd expect from their goal of tracking the total market. Other indexes follow just a few stocks- most famously, the Dow Jones Industrial Average (built during an era of when it had to be calculated by hand every night) looks at just 30 stocks in a weird way(1).
The S&P 500 isn't either of those. It has a list of criteria for inclusion, one of which is profitability. They are sticking with that criteria. If you don't like it, sell your VOO and buy VTI instead.
1: It is essentially impossible to build an index that tracks the DJIA because, since it was done on pencil and paper, it isn't actually market-cap weighted, but is share price weighted, with a correction factor for each stock to account for splits, one stock replacing another, etc. Because of that nature, the weights of the DJIA change minute by minute, so someone attempting to track it would be subject to enormous error.
> Because the index needs accuracy
So you are saying that S&P 500 should be merged with Russell 2000 or rather just become a fully market index to be more "accurate". You do know that's something that exists already, having different indexes makes perfect sense and consumers can pick the ones they want based on their risk profile and preferences.
> most civilization changing companies from the benchmark
It took Google 2 years to get into S&P 500. For Microslop it was 8 years (!). So what's new?
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Maybe you know this already, but this reads like exactly the kind of reasoning that people looking back at irrational market euphorias point to as a sign things were about to go awry.
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> If a company is 1-2% of the total US market cap and not included in the index, then the index is wrong right now.
To be clear, S&P 500 relies on float, not total US Market Cap, and Space X will have a tiny float.
Even if it was included, SpaceX would not account for 1-2% of the S&P 500 (more like 0.1%), so even if we reason on the basis of a benchmark, it's not a meaningful difference.
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> Because the index needs accuracy.
No, it doesn't. At least, not the way you are probably defining it.
This sounds to me like you may be trying to use the index for something it's not really meant to be used for.
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But it is not 1-2% of the total US market cap, is it?
It aspires to be that way. The market decides, and it hasn’t decided yet.
Am I missing something?
> If a company is 1-2% of the total US market cap
Over what time horizon should that number be computed? Every day? Every second? Every month/quarter?
It is not as simple as it seems.
> These companies will likely never meet S&P profitability inclusion criteria for the next 5 years.
They won't stay gigacaps for 5 years if they don't become profitable. At their size, they can't just keep burning money at that scale under the public's eyes. The funding will divert from VC to shareholder equity and that will quickly see they don't stay gigacaps.
So this is a self correcting problem. Either they'll start making money and hit profitability targets or their market cap will diminish.
I'm with you on this part:
> Because the index needs accuracy. If a company is 1-2% of the total US market cap and not included in the index, then the index is wrong right now. The longer this company is not in the index, the longer this error compounds. In the coming few months, multiple giga-cap companies (SpaceX, OpenAI, Anthropic) are all planning to IPO.
I'm nodding vigorously on this part:
> These companies will likely never meet S&P profitability inclusion criteria for the next 5 years.
But here, you lose me…
> These are not bad companies, but because the S&P inclusion criteria were written for old GAAP profitable companies, and not high-growth companies that invest their cashflow into company growth over profits. Excluding some of the most civilization changing companies from the benchmark means the benchmark is doing a terrible job.
The point of investing in a total(ish) index of the public stock market is to invest in companies that have a reasonable expectation of net-positive future cash flows, justified in part by legally-mandated transparent reporting of their finances.
You can't just buy every publicly-traded stock though: for one thing, that would massively incentivize obvious scammers to do the bare minimum to get their stocks included, and drag the index down. Avoiding companies that are illiquid, non-transparent, or lacking in a clear track record is important. The SpaceX IPO bears more than a passing resemblance to a pump-and-dump scheme:
1. SpaceX's line of business* is tremendously unclear.
2. SpaceX doesn't actually need external capital to fund its operations.
3. SpaceX is floating only a tiny fraction of its putative market capitalization.
4. The main purpose of the IPO appears to be to allow insiders to cash out.
5. The way the lion's share of the IPO gets sold is if large index funds and pension-holding companies demand shares, and that only happens with the index-inclusion exceptions we're discussing here.
So, we agree that these "mega cap IPO" companies won't be profitable in the next 5 years. That's a huge period of time. How can public markets accurately value a company that isn't expected to be profitable for such a long period of time; there are so many things that could change their trajectory towards profitability, all the more so if we accept your premise that these companies are "civilization changing."
My conclusion is that it's perfectly fine, even beneficial, for indices like S&P 500 to avoid any special treatment for these companies. If SpaceX is clearly profitable 5 years from now, and has reached 50% free-float, that seems like a good time to start including it in the index.
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* Nearly all of its revenue comes from launching satellites and running a satellite-based communications network, but much of its putative valuation comes from a hastily glommed-in also-ran AI company, and its association with a person who is famous for running other businesses and for political connections.
If they're doomed, they're bad companies. This isn't complicated. You can run a fraud and double down real aggressively and as long as you're not called on your bullshit you look incredibly good, until you don't.
If they're doomed, they're bad companies. You can make the argument they're not doomed, but that's a separate argument.
If a significant percentage of the market is excluded from the index because they don't meet index inclusion criteria, then then index stops being a useful benchmark.
If you change a benchmark whenever you think it'll be 'wrong', then it becomes a measure of the heuristics you use to predict what'll impact the benchmark rather than a benchmark in its own right.
S&P claims their S&P 500 product is the "best single gauge of U.S. large-cap equities". For this benchmark to be accurate, at a fundamental level, this benchmark has to follow the market and reflect current market conditions.
The market decides what the large-cap U.S. equities are, not S&P. If S&P excludes some of the largest U.S. companies, which based on their current rules, will exclude all of Anthropic, SpaceX, and OpenAI; then they do a poor job reflecting the benchmark they claim to follow.
It's not S&P's fault that market conditions have changed.
this benchmark has to follow the market and reflect current market conditions
Sure, but right now they don't know how the market will react, so changing the index rules before there's any data would be a measure of their heuristics (e.g. what they believe the market will do), not a measure of what the market is actually doing.
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Matt Levine, who probably knows more about finance than anyone on this site, has said the same thing. He’s also talked about all the hate mail he gets. Large market etfs like VTI or VOO are supposed to track the market. It would be weird if they ignored trillion+ market cap companies. If the market decides to dump these companies then they’ll fall out of the index.
Index criteria have also changed many times over the years, and they are changing again to deal with later stage companies coming to the market with already huge valuations.
Yes, Matt Levine said that, but he also argued the other side's point of view, as he regularly does.
I completely agree. People have parroted the benefits of passive investing and blindly following the benchmark index for decades, yet the instant some overpriced turds (Anthropic, OpenAI, and SpaceX) are considered being adding to the benchmark, they backtrack and fight tooth and nail against including them.
All three companies are large enough by market cap ($1T+) to qualify for the S&P 500 benchmark, which claims to track the top 500 largest U.S. large-cap equities.
They have a point (not wanting to invest in overpriced equities), but if you don't like the companies that surface through passive investing then don't be a passive investor. It sounds like these people want active investing instead. If that's your position, just buy actively invested funds, not ruin the benchmark for everyone.
S&P is caught in a bind, because if they add these companies to the index, it would aggravate millions of passive investors.
While there's some truth in your point, I think you're being unfair in framing this story as passive investors betraying their own philosophy because they suddenly realize this passivity would cause some "overpriced turds" to be included in their portfolio.
Passive investors did not "backtrack", on the contrary their preference on this matter is that index rules should remain unchanged. Conversely, it seems fully consistent for a passive investor to criticize Nasdaq-100 for actively amending their rules to achieve a specific result.
So I find it rather unfair to conclude that "these people want active investing instead". As far as I know, these people are reacting to "active" decisions (such as Nasdaq-100's) and cheering actual passivity (such as S&P500's decision).
Now, one can argue that there are good and legitimate arguments for the inclusion rules to evolve, but by definition amending the rules is an active decision.
I don't care about being forced to own SpaceX if it's in the index, I do care about it being forced into the index before it's had a chance to settle, so that private investors can dump on me.
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Market pricing will be interesting. People have been complaining about TLSA being over priced for years and now it's 2%+ of the S&P. Are people selling VOO and VTI because of the TSLA allocation? Nope, in fact TSLA has made them all a lot of money.
People were falling over themselves to invest in these AI companies and SpaceX not that long ago. 75B worth of SpaceX now has to get sold to IPO investors to hit the desired valuation. People say a lot (especially on the internet), but when the rubber meets the road we'll see what people do with their money.
The other bind the S&P is caught in is if these AI stocks IPO and then moonshot before they get added. The question will then be is the S&P an antiquated index? How do multiple trillion dollar companies in the market not end up in the S&P 500 sooner? No one thinks of that case because everyone is so sure they are all going to zero.
It’s a benchmark of the market under certain rules, like having multiple quarters of earnings for the market to value them at.
These companies want special exceptions. If you are an exception why should you be included in a benchmark? At best they should have an asterisk against their name like Sammy Sosa or Mark McGuire if they are not following the same rules.
Your baseball cheating analogy makes no sense here. Rules against corked bats / steroids exist so people don't cheat at a sport and all players can compete equally. S&P rules are supposed to make the index reflect the market. Totally different.
The profitability requirement is something made up by the S&P committee. If that rule ends up excluding trillions in market cap, the rule has defeated its own purpose. The 12 months of profitability requirement punishes high-growth companies that invest their FCF into growing the business vs taking profits.
It excludes companies like Amazon, which when ran by Bezos, was famously unprofitable and invested all free cash flow into growing the business and never turned a significant profit until >20 years after its founding.
> S&P rules are supposed to make the index reflect the market.
Where did you find that? Link?
I ask because common understanding is that the index is a stable tracker of the market, specifically to exclude volatility.
IOW, it reflects a smoothed market, not a point-in-time-with-daily-granularity market. I would really like to know where you read what you read.
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What is it a benchmark for? All investable public stocks or the economy writ large?
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> Rules against corked bats / steroids exist so people don't cheat at a sport and all players can compete equally.
> The profitability requirement is something made up by the S&P committee.
Those are both equally made up. In this case the rules are being changed for new entrants into the market such as SpaceX for the Nasdaq and other benchmarks that are allowing it for that none of the previous companies in said index were allowed to get in under.
And since it’s 15 days and I know most companies have lockout terms on the order of months for various levels of stock, I’m hesitant to believe this won’t modify the benchmarks beyond what has happened with previous inclusions.
`JumpCrisscross’s reply to one of my other comments on this thread in regards to the S&P being a committee based decision actually has had me pause to think, but your argument that the rules are arbitrary so it can’t be cheating like my baseball analogy fails to land.
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It may be used as a benchmark, but that’s not actually the purpose of it. The purpose is to serve as a way for people to invest in a representative sample of the market. It can still be a representative sample with safeguards. If you want a benchmark without safeguards, you can calculate one without risking millions of people’s life savings.
You have your history backwards. The S&P 500 was created in 1957 as a benchmark. The first investable index fund tracking it (Vanguard's) wasn't created created until 1976. Vanguard created their fund to track the benchmark, not the other way around.
And if you need a second, different index to function as the true market benchmark because the S&P 500 no longer reflects the actual market, then you just agreed the S&P 500 is no longer an adequate benchmark. You just agreed with my point.
Because it's selective, the S&P by definition does not reflect the actual market. It reflects a subset of it.
If you're comfortable with this notion of what the S&P does, then you ought to be comfortable with S&P applying the same methodology they've always used. There are other indexes you can reference if this particular sampling of the market isn't to your personal liking.
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> the S&P 500 no longer reflects the actual market
Well it was never intended to reflect the full "actual market".
> no longer an adequate benchmark
According to your definition it never was. However there were and are plenty of other index benchmarks which serve different purpose. Its just that S&P 500 managed to become the most popular one, why did it happen if it was always inherently flawed?
Like they didn't even add Microslop for 8 years...