Tesla’s S&P Entry Sets Up a Departure Later Today: Taking Stock

Since news broke a month ago that Tesla Inc. will join the S&P 500 Index, investors have been left to wonder which company will be dropped to make room for the electric car maker. That wait will be over shortly after the markets close Friday.

Predicting S&P 500 deletions is as much art as science, particularly this year, when faced with an economic disruption that may prove temporary index overseers have resisted rash moves. That said, certain metrics exist that, while by no means certain, may give a back-of-the-envelope idea of who is at risk.

Several of them govern thresholds needed to get into the index in the first place, various profit and market-value guidelines for inclusion — through none of them say anything about when a company would get booted. One is four quarters of profitability. Right now, 47 companies fail to make that cut. Another is minimum market capitalization of $9.8 billion. Combined, 14 firms are failing by both criteria. There will be just one deletion to make room for Tesla.

That list includes: NiSource Inc., Norwegian Cruise Line Holdings Ltd. , Mosaic Co., Diamondback Energy Inc., Perrigo Co., Alaska Air Group Inc., Devon Energy Corp., DXC Technology Co., Apache Corp., National Oilwell Varco Inc., Marathon Oil Corp., Ralph Lauren Corp., HollyFrontier Corp. and TechnipFMC Plc.

Still, failing to meet those requirement doesn’t mean an immediate removal. The requirements for staying in the index aren’t the same as for getting in, per the the S&P Dow Jones Indices, and if a company temporarily violates one or more of the requirements, there’s no guarantee it will be kicked out. The exclusion process takes into account factors like liquidity and the stock’s representation of the industry it belongs to, according to Howard Silverblatt, senior index analyst at S&P Dow Jones who isn’t a member of the S&P 500 committee. At times like this, the decision becomes both a science and an art.

“The question is — do you give this company or that company another six months because it’s had a rough go, but there’s a high chance it will bounce back?” Silverblatt said by phone. He isn’t associated directly with the decision to put in Tesla. “At which point do you pull the trigger? It’s not liquid, it doesn’t represent the market, it has to come out. But there are a lot things that have to be taken into account.”

More often than not, a company is dropped because of corporation actions, such as takeovers. Right now, Tiffany & Co. and Varian Medical Systems Inc. are being acquired in separate deals expected to close next year. Whatever today’s decision, due at 5:15 p.m. in New York, the stocks that risk a potential exclusion are likely to see higher volume and potentially wider price swings.

The S&P 500 inclusion, which will take effect at the start of business on Dec. 21, will have an outsized effect on Tesla and the index itself. The stock will be the largest ever addition to the index, and fund managers will need to sell a portion of other S&P 500 constituents to raise cash to buy Tesla shares.

“This typically is not a big deal, but due to the unprecedented size of Tesla, the amount of shares that will need to be sold across all the other S&P 500 constituents will be significant and we could see substantial impact across the entire index,” said Ivan Cajic, head of index and ETF research at Virtu Financial.

S&P 500 futures are trading 0.6% lower at the end of a choppy week that’s seen just one session of gains. Futures declines are following losses in Europe amid fresh headlines about a no-deal Brexit and stalling stimulus talks at home over whether to shield companies from virus lawsuits. Oil is trading little changed, but that’s not helping energy firms and airlines that are solidly in the red. Disney is up 8% after unveiling a promising slate of upcoming movies. Airbnb is trading lower after a 113% jump in its trading debut Thursday.

Notes From the Sell Side

Deutsche Bank downgraded its view on the airline sector, writing that while it still had a bullish view of the group over the long term, the group looked fairly valued following a recent rally. American Airlines, Allegiant Travel, Alaska Air Group, Delta Air Lines, JetBlue Airways, Southwest Airlines, Spirit Airlines, SkyWest, and United Airlines were all lowered to hold from buy. The group is up 60% off an October low, based on the NYSE Arca Airline Index. With this gain, “stocks are at or near fair value based on 2022 valuations (and in some cases, 2023), suggesting to us that investors’ have already paid for two years of earnings growth,” wrote analyst Michael Linenberg.

Morgan Stanley upgraded its view on exploration and production companies to attractive, writing that “the foundation appears in place for a sustained rally” in 2021. The companies are not only “potential outsized beneficiaries of ‘reopening,’” but they should see “competitive, through-the-cycle [free cash flow] generation.” As part of its call, analyst Devin McDermott upgraded Diamondback Energy to overweight from equal weight, and both Murphy Oil and Range Resources to equal weight from underweight. ConocoPhillips, Cimarex Energy, and Diamondback were all named as top picks.

Ralph Lauren was upgraded to buy at Citi, which wrote that the apparel company was “making the right moves to upscale the brand.” The company is positioned to cut a “meaningful amount out of its expense base,” and it can “significantly increase” its earnings in the coming years.

Sectors in Focus

  • Pfizer and BioNTech are up 2% after their coronavirus vaccine got a nod from a panel of FDA advisers in a 17-4 vote. Moderna is up 1% before the bell. Watch AZN, MRK, LLY for a reaction.
  • Watch chipmakers after Broadcom’s quarterly results and forecast were roughly in line with estimates. Shares are trading 1% lower before the bell. Peer QCOM pay react.
  • Watch meal kit and online food and beverage ordering firms after Blue Apron said its quarterly results would top the firm’s previous forecast. The company also said its CFO is resigning at the end of the year. HLFFF, TKAYY, GRUB may react.
  • Lululemon reported sales and earnings that beat estimates as online sales boomed, but investors apparently wanted more. Shares are down 1% premarket. Watch NKE, UAA for a potential move.
  • Bitcoin is trading lower for the fifth consecutive day. Watch bitcoin-related names GBTC, OSTK, MARA, DPW, RIOT.

Tick-By-Tick to Today’s Actionable Events

  • 5am– JOUT earnings
  • 8:30am– PPE Final Demand MoM, YoY
  • 11am– U. Mich Sentiment
  • 3:30pm– CFTC data
  • WLTW/AON – New Zealand expires
  • CBB/Macquarie – Hawaii statement of positions deadline

— With assistance by Ryan Vlastelica

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