Time to Ditch the S&P?
By: Austin Brand
Tags: Facebook, Google, Investing, Tesla, Index Funds

The S&P 500 has returned over 200% in the past 10 years, in large part thanks to the top tech firms. With Tesla’s inclusion to the index and Google and Facebook facing antitrust suits, some investors may be doubting the kind of high-growth companies that had benefited them so greatly. It begs the question: Is time to switch from the S&P and seek other options?

The widely used stock market index consists of 500 of the largest publicly traded companies. It is a market-capitalization-weighted index, which uses the total market value of firms’ outstanding shares to weight it. The firms with a higher market capitalization make up a higher percentage of the index. Apple’s market cap, which is over $2 Trillion, represents over 6%. The next two biggest holdings, Microsoft and Amazon, represent over 5% and just over 4% respectively. One of the smallest components, Unum Group, whose market cap is a little over $4 billion represents just .01% of the index.

Perhaps the biggest benefit of market-cap-weighted indexes is the fact that they take advantage of momentum. The high performing companies’ weightings increase, while the poor performing shares shrink. This has led to the top 5 big tech firms (Apple, Microsoft, Amazon, Google, and Facebook) making up over 20% of the S&P 500 (with Tesla coming in at 6th). While this has paid off big time with strong “S&P 5” performance, if these top firms begin to underperform, it could mean trouble for the index. Although underperformance may be a concern, big tech’s prominence in our increasingly virtual world should limit some of this downside.

The Impact of Tesla

Tesla’s addition to the S&P 500 has been a hard pill to swallow for many people invested in the index, who may have missed out on the company’s over 700% year-to-date return leading up to its inclusion.

Tesla’s returns have dwarfed those of the S&P 500, which has still produced strong returns in 2020.

While it’s hard to argue that there hasn’t been some irrational exuberance involved in this run-up, and the stock has dropped since being added, it probably isn’t time to panic and sell off funds that track the S&P 500. Tesla currently makes up about 1.6% of the index. With this weighting, Tesla could give up all its gains from the past two years, dropping 90%, and it would only bring the S&P down around 1.4%. It is also important to be aware of Tesla’s bull case. This includes their strong presence and potential growth in China, their insurance program, high margin software-driven upgrades, the fact that they are viewed as the future of autonomous driving, and that they represent the future of electric and solar power. While likely overvalued at the moment, the limited downside of Tesla’s inclusion with its 1.6% weighting in the index, in conjunction with Tesla’s bull case, should ease the fears of those invested in the S&P.

Antitrust Concerns

Although Tesla’s inclusion alone shouldn’t be too serious of a reason to worry, there could be others. Earlier this month the FTC and 46 states sued Facebook, accusing it of buying and freezing out startups to limit competition. Some of the deals in question include their acquisitions of Instagram and WhatsApp.

This news came a couple of weeks after the Justice Department had filed an antitrust lawsuit against Google, alleging that they have used anticompetitive tactics related to its search engine and advertising business. The suit is predicated on the claim that Google uses its billions of dollars in ad revenue to pay for the right to keep Google as the default search engine. This can be seen as creating a self-reinforcing cycle of supremacy as essentially the lone search engine. While it could be argued that it is up to us to pick our search engine, the danger lies in the fact that humans suffer from a default bias. We tend to accept the option we’ve been given and just move on. Facebook and Google have also been accused of cutting a deal where Facebook agreed not to compete with Google’s online advertising tools in return for special treatment when using them. As a part of this deal, they also agreed to cooperate and assist each other if they ever faced any antitrust action as a result of their pact.

Major hurdles for the government will be the fact that they had previously approved Facebook’s transactions, and that they will be going up against the tech giants high powered lawyers. Considering both Facebook and Google’s cases will likely take years to resolve and the uphill battle for the government, the two firms’ legal issues don’t appear to be a reason to flee the S&P for now.

S&P 500 Alternatives

It could still be wise to diversify, or just be aware of some potential options to protect you if things for the top firms in the S&P do go south. Some ETFs to look at could be the Invesco S&P SmallCap Information Technology ETF (PSCT) and the Invesco S&P 500 Equal Weight ETF (RSP).

PSCT could benefit greatly from continued pressure on big tech firms and potential breakups. If some of the anticompetitive behaviors top tech firms have been accused of are forced to subside, it could allow smaller tech firms to flourish. Investing in PSCT would give exposure to a wide variety of these companies and eliminates some of the volatility that comes with investing in singular small-cap tech firms.

In equal-weighted indexes, every company represents an equal amount of the index. As a result, each firm in RSP would carry a weight of around .2% (.2% x 500 = 100%). Investing in this ETF could reduce exposure to Tesla and the other top tech firms and provide more exposure to smaller companies that may have been neglected in recent months.

It’s natural that Tesla’s inclusion, such a heavy weighting from tech giants, and antitrust lawsuits against some of these top firms, may give investors pause about investing in the S&P 500. Considering the limited downside of Tesla’s inclusion, big techs continued prominence, and the arduous journey ahead for government legal teams, it probably isn’t time to abandon the index, though is still important to be aware of potential risks and all your options.