These Stocks Could Rally Once They are Added to the SP500 Index
The SP500 stock index consists of, well, 500 stocks.
However, every so often Standard and Poors (the SP part) will adjust the basket of 500 stocks they use in their index to better reflect the US stock market.
There are many conditions a company must meet to be part of the index, including liquidity, market capitalization and share float to name a few.
Why Do Stocks Rally Once They are Added to the SP500 Index?
The emergence of ETFs as a low-cost passive investment vehicle for the public has attracted a lot of buying volumes into stocks that are listed on indices.
Think of it this way, a company creates an ETF that promises to perform at least as good as the SP500 index. What does this company’s portfolio manager have to do?
Buy all of the shares in that index to replicate the performance.
Now imagine there are thousands of companies that invest into an index as part of their portfolios.
What happens when the SP500 index removes some stocks and adds others as replacements?
The stocks that are removed are sold by the institutional managers and they use the proceeds to purchase the new stocks in the index. This is called portfolio rebalancing.
Now you can see why stocks rally once they are added to the SP500 index, and the ones that are removed tend to drop in price.
What Stocks are Being Adjusted this Time Around?
On June 19th, 2017, the SP500 will rebalance the index by making the following adjustments:
- IHS Markit Ltd (ticker: INFO) will replace TEGNA Inc (TGNA)
- Yahoo (YHOO) will be removed on June 19th, 2017 (replacement will be named later)
As part of the quarterly rebalancing, the SP will also be adding Cars.com (CARS) to their SP400 index, as well as removing JC Penny (JCP) and Time (TIME) from their midcap 400 index. The retail sector has been hit hard, and it is not surprising that JCP is no longer representative of the mid-cap stock market space.
To be clear, these adjustments would favor INFO as managers rush to buy the stock for their portfolios, while having to sell YHOO if they own it.
As you can see from the weekly stock chart of INFO below, it has already enjoyed a pretty hefty rally so be cautious as not to buy the top:
How Much Will Stocks Rally Once They are Added to the SP500 Index?
Stock companies have rallied an average of 5% once they were included in an index, as fund managers rush to get in.
However, portfolio managers know about this effect, and tend to purchase small quantities frequently to prevent a big run up against their buying activity.
Despite making an effort to hold back, it is a simple equation, when demand increases for a stock and all else remains constant you can expect the price to increase.
Before you go out and spend your entire retirement account buying INFO shares, remember that nothing works all the time and there are no guarantees of performance in the markets. No strategy is fool proof or right all of the time. As always, exercise strict money management and do your own research and analysis before making investment decisions.
Have an awesome day!
Join our live trading room as part of our day trader pro package – more info here >
Find out how to trade options in a passive way with trade ideas and analysis – more info here on our options pro package >
The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.