After the announcement that a stock will be newly included in the S&P 500 Index (SPX), a surge in the stock price often follows, known as the “S&P phenomenon.” This week, Crowdstrike (NASDAQ:CRWD), KKR (NYSE:KKR), and GoDaddy (NASDAQ:GDDY) experienced this phenomenon as they are set to replace three stocks being removed from the index.
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The sudden spike in price after being added to a major index is largely driven by the immediate demand from institutional investors managing indexed funds. These funds are obligated to include the new stocks in their portfolios to earn returns, causing a surge in buying demand and resulting in a price increase.
When and Why the S&P Rebalances
The S&P 500 rebalances its composition quarterly. While the index doesn’t own stocks, it measures the performance of the 500 stocks within it and weights their performance based on market capitalization.
Investors often observe the resulting phenomenon when the S&P rebalances four times a year. The rebalancing announcement typically happens after the market closes on the first Friday of March, June, September, and December, with the actual rebalancing occurring after the close of business on the third Friday.
S&P 500 Criteria for Index Inclusion
Companies vying for inclusion in the S&P 500 must meet stringent criteria set by the S&P Index Committee. These criteria include U.S. domicile, trading on a U.S. stock exchange, extreme liquidity, positive earnings, and sound creditworthiness.
Moreover, prospective additions must maintain substantial market capitalization to ensure the representation of the largest, healthiest companies in the market.
New Members to the Exclusive S&P 500
The market opening this week after the Friday announcement sparked abundant trading activity, with shares of the incoming constituents scoring large gains.
By the close of trading on Monday, KKR led the charge with an impressive 11.2% gain on the session, Crowdstrike rose 7.3%, and GoDaddy was up 1.92%. It should be noted that these increases are in addition to the outsized gains they racked up after-hours post-announcement (Friday).
These quarterly occurrences, leaving most investors wishing they had a crystal ball, highlight the significance of these Fridays.
What About the Old Members?
Fund managers are scrambling to get as close to the price as possible that the S&P 500 will use to include the new stock in its composite index. Simultaneously, they are caught up in a selling frenzy for those departing the index.
This quarter, Robert Half Inc. (NYSE:RHI), Comerica Inc. (NYSE:CMA), and Illumina Inc. (NASDAQ:ILMN) endured removal. Robert Half gained 1.5%, while Comerica dropped 1.66%, and Illumina was down 3.4%.
Robert Half and Comerica will find a new home in the S&P SmallCap 600, while Illumina transitions to the S&P MidCap 400.
Key Takeaway
The S&P phenomenon, characterized by a sudden surge in a stock’s price upon its addition to the S&P 500, happens every quarter. During periods of significant shifts in market or industry leadership, the list of such stocks may extend beyond the usual three observed this quarter.
In between quarters, mergers of two S&P 500 companies can also prompt S&P to add a new company to the composite. The names being considered for addition are held in secret and released on Fridays after the close of trading. This announcement sparks a frenzy of buying and selling activity for these companies.
