Indexed

Is it good to be part of the collective?

From Karl Marx to Friedrich Hayek, polemics ring like swords and plowshares on anvils.

But that’s not what we mean.

When Vanguard in 1975 created the 500 Fund, many called it “Bogle’s Folly,” suggesting founder Jack Bogle’s plan to buy and hold a collection of stocks on the notion that the wisdom of crowds was better than that of individuals was daft.

Today the Admiral Shares version (the original fund closed to new investors and Vanguard points them to its Exchange Traded Fund VOO tracking the S&P 500, with $560 billion of assets) manages over $530 billion of indexed money tied to the S&P 500.

Jack Bogle was not daft. Passive money dominates, and it exploded after Regulation National Market System, the stock market’s equivalent of the IRS code, ordered stocks to trade at an average price by imposing the National Best Bid or Offer (the NBBO).

Now Dow Jones S&P is reshuffling the Dow Jones Industrial Average (DJIA), removing XOM, RTX and PFE and replacing them with HON, CRM and AMGN.

Aside: I’m at the Benzinga Trading Boot Camp this Friday at noon ET. It’ll be a good 30-min look at market structure. Sign up for EDGE and follow along. It’s free, and I’ll show you how to use it.

Back to the narrative, if you follow the money and it’s benchmarked, then indexing should be good for investors, good for public companies. By extension, getting booted from the collective is bad. Indeed, the issues ousted were down, the ones added were up, though changes don’t occur till Aug 31.

It’s worth noting that a key futures contract used to true up S&P 500 exposure and hedge general market moves expires the last trading day of the month, which is Aug 31. All six stocks are in the S&P 500 and AMGN is in the Nasdaq 100 too.

And all are in many ETFs. RTX populates the fewest (150), AMGN the most (285) with the rest scattered between. XOM is in 269 despite declining 72% year-to-date. Why would the collective choose XOM when it’s down? And Energy is just 3% of the market?

Because ETFs use stocks as collateral. Market-makers trade XOM for S&P 500 ETF shares because they profit on the spread. Sponsors trade it back for appreciated ETFs but supply less than they received. Both parties win, and the sponsor earns ETF fees to boot.

Few know what I just described. It’s the principal objective of the parties trading ETF shares wholesale. If you want to understand, ask me.

CRM is in 208 ETFs and up 29% this year and Tech is 27% of the DJIA. In fact, Tech is the trigger here. AAPL announced a 4-for-1 stock-split that will drop it sharply in the price-weighted DJIA. To offset that effect, Dow Jones is rejiggering.

You still with me?

AAPL’s coming stock-split whacks the DJIA from 27% Tech to 20%, so CRM joins, getting the index back to 23% (thanks to CNBC’s good take for that insight).

CRM instantly becomes #6 in the DJIA, AMGN #3 (is it now overexposed to Healthcare, with UNH #1 after the AAPL split?), HON #11.

In a sense, these moves are risk-management for the index creator. Depend too much on one stock and your index can get shellacked. Out over the skis in a sector? Pick somebody who gets you lined up with gravity. CRM is in because it puts Tech in a reasonable range again in the index.

It’s a profound point, frankly. The index is less about the economy, more about the collective. Not that there’s anything wrong with that – unless you think the index is about the economy.

Now, what should we conclude about getting indexed, or not? It matters little if you’re big. All six of these issues will continue to be ETF fodder, continue to be priced more by market structure than story.

So traders should use market structure, not just fundamentals. If you want to know more, tune to Benzinga Premarket Prep today (Aug 26) at 835a ET (there’s a replay). I’ll be talking about our sister company, Market Structure EDGE.