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| The Dow Jones Industrial average is the best-known stock market measure, the Nasdaq Composite the most volatile. But perhaps the one that matters most is the Standard & Poor's 500-stock index (for a video interview with S&P's David Blitzer on how the S&P 500 is put together, click here). More than $900 billion in retirement accounts, mutual funds, endowments, and the like is invested in portfolios of stocks that mimic the index. It's also the benchmark against which money managers are judged.
The reason for its importance is simple: The S&P 500 is a proxy for the U.S. stock market as a whole, a reflection of what ``average'' stocks are doing. That was certainly true in the 1970s when indexing and benchmarking took hold. A quarter-century later, the S&P 500 has evolved into an index dominated by large-capitalization stocks of companies with fast-growing earnings, the current profit slump excepted.
The upshot: The S&P has been ``transformed into a growth stock index, becoming far riskier than it was supposed to be,'' says Horace ``Woody'' Brock, president of Strategic Economic Decisions and a consultant to pension and hedge funds. David M. Blitzer, chief investment strategist for S&P and chairman of the seven-member committee managing the index, takes exception. With the index, he says, the committee aims ``to reflect the stock market and the U.S. economy.'' (S&P, like BusinessWeek, is a unit of the McGraw-Hill Cos.)
The S&P 500's new personality stems from the increasing importance of information technology companies in the economy and in the market. When investors bid up tech stock prices, they increase the weight of the shares in the index. And in this index, weight is everything. The greater a company's market value, the greater its impact. A 25% gain in the price of No. 1 General Electric Co. (GE
), about 4% of the S&P, will boost the index 1%. But J.C. Penney (JCP
), stock No. 375 with a 0.04% share, would need a 2,500% gain to move the index 1%.
THE WEIGHT OF TECH. Look at the changing industry composition of the index (chart). Technology companies climbed from 6.5% of its value in December, 1990, to 34.1% just before the market's March, 2000, peak. Even with the tech plunge, the stocks account for 20.5% (as of Feb. 28). Over the past year, oil and gas stocks have been on a tear. Indeed, energy companies displaced many techs in this year's BusinessWeek 50, which is drawn from the S&P 500. Even so, energy's share of the 500 pales, at only 6.6%, down from 13% in 1990 and 22.7% in 1981.
Not all of tech's prominence results from market action. The number of tech companies in the 500 has doubled to 82 since 1994 as the committee put tech companies in the index to replace non-tech companies that have fallen out. Many, but not all, come out because they're taken over. A record 58 companies were booted last year, 18 of those because they were deemed too small or no longer representative of their industries. That's a new twist. In the past, the committee tended to remove stocks only when they were taken over, restructured, or bankrupted. ``We're looking for leading companies in leading industries,'' says Blitzer. He wants the index to do better than track the average stock. And while he says it should reflect the market, he also wants the S&P 500 to make money for all those who index to it.
Such sentiments and the changes have Wall Street talking. Abby Joseph Cohen, chief investment strategist at Goldman Sachs, recently reminded clients that the index is not the objective benchmark it was: ``The individuals who run the index typically remove companies with disappointing earnings growth, [replacing them] on a regular basis with faster-growing, more successful companies.'' Says Richard Bernstein, chief quantitative strategist at Merrill Lynch & Co.: ``My perception is that they wanted to get hotter stocks.''
As they inserted hot tech issues that were also in the Nasdaq, they raised the price-earnings ratio of the entire index. And with higher p-e's comes greater price volatility. Ten big techs, added in the 1990s and now comprising 8% of the index, carried an average p-e of 45 at yearend. That was more than double the average for the entire index, says Steve Galbraith, investment strategist at Morgan Stanley Dean Witter.
Blitzer says the committee is not meddling as much as it might appear to be. ``I don't think it is about chasing hot stocks,'' he says. The committee does not seek specifically high earnings growth. Blitzer points out that the group has also chosen members from slow-growing industries, such as auto-parts-maker Visteon Corp. (VC
), a spin-off from Ford Motor Co. (F
) The index's higher p-e stocks, says Blitzer, only reflect the market's shift to higher p-e's.
But bringing more richly valued stocks into the index, say critics, just ends up making those same stocks even more overvalued. Merrill's Bernstein points to the addition of Yahoo! Inc. (YHOO
) in December, 1999, and America Online Inc. (AOL
) a year earlier. The announcements triggered another buying frenzy as index funds scrambled to get them into their portfolios. AOL gained 30.2% right after the announcement; Yahoo, a record 63.6%.
EARNINGS REQUIRED. Even with Yahoo, Blitzer says members felt pressure to bring in even more Net stocks because the S&P 500 was looking wan next to Nasdaq. But the committee has required companies to have earnings and relatively stable businesses, and AOL and Yahoo were practically the only Internet stocks with earnings. ``We argued about it at length and decided we didn't want to change our opinion on financial viability,'' says Blitzer. No other Internet issues were added. In retrospect, by sticking with its policy, the committee saved S&P 500 index investors billions of dollars.
Does this mean the S&P has had enough of tech stocks? Not at all. Blitzer thinks it's still slightly underweighted in technology relative to the overall market. So the committee will no doubt be looking to add more tech names when the next openings arise. Index watcher Diane Garnick at Merrill Lynch thinks Juniper Networks Inc. (JNPR
), which builds Internet routers, is a good candidate, as is Cadence Design Systems Inc. (CDN
), which develops software for automating chip design.
Whether index investors approve of adding more tech or not, they should know that as times change, so does the S&P 500. In fact, it's moving target. |
Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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