Radical Shifts to Occur in Popular Index Compositions Amidst COVID-19 Crisis

  • May 27, 2020 AEST
  • Team Kalkine
Radical Shifts to Occur in Popular Index Compositions Amidst COVID-19 Crisis

Summary

  • Global equity markets bouncing back after March 2020 crash, instilling optimism in investors as COVID-19 crisis subside.
  • Billions wiped out of equity markets since the beginning of 2020 and operators of the benchmark S&P Dow Jones Indices contemplating removal of underperforming and wounded companies, no more complying with the minimum requirements amidst expectations of a recessionary scenario.
  • Market volatility remains high with economic recovery to take time. 

 

Coronavirus pandemic has profoundly impacted the world, causing a threat to public health, disrupting social and economic dynamics while affecting long-term livelihoods and well-being of millions. Market analysts and experts are fearing a recessionary scenario as contractions in economic activity and decline in spending propelled the government to intervene and inject billions or trillions worth of liquidity into their respective economies to keep them afloat amidst the crisis.

The stock markets came crashing, particularly in March 2020, as revenues and cash flows of most companies got impacted, instilling a negative sentiment amongst the investors. Major indices around the world gave up huge gains. Hospitality and airline industries have been hit the hardest with strict social distancing and travel restrictions in place. 

However, an interesting phenomenon, amidst all the global turbulence, to note is that equity markets across the globe have been recovering throughout April 2020, perhaps due to the optimising stemming out of massive stimulus packages that have been released by various governments like the United States, Australia, India, Australia and Japan. The US Fed has even committed to lend or buy trillions of dollars of financial assets. Others like Japan and the European Central Bank are following suit in various capacities.

This perhaps has led to the recent rally in equity markets. However, actual health of the global economy is not as sound and global equity indices have somehow failed to capture that. Most of the countries are projecting a fall in their growth rates and estimating that the recovery is going to take time, as different countries begin to reopen their economies. In fact, the physical market for crude oil is on the brink of a collapse.

Interesting Read Conventional Way of Re-opening Economy in Uncertain Times – US, UK, Australia and China  

Having said that, operators of the benchmark S&P 500 Dow Jones Indices, the stock market index tracking performance of 500 large companies listed on stock exchanges in the US, are in a perplexed situation and postponed the quarterly rebalance for equity indexes–including the Dow Jones Industrial Average and S&P 500 Index amidst extreme volatility. In short, the world’s most followed stock index may be all set for a radical transformation.

In Australia too, S&P has postponed March Quarter rebalancing of the ASX 200 against a volatility market landscape, which could possibly result in cost savings for exchange-traded fund (ETF) investors. However, at the same time, it raised the question about the passive /active nature of the indices.

The S&P Dow Jones Indices committee is struggling with whether to eliminate the underperformers and wounded companies with eroded market capitalisations, out of the index to keep up with the rule book of minimum requirements and standards. The key factor that has propelled the recovery of this passive index is the presence of extreme weightage of technology and healthcare sector stocks.  

How is Coronavirus Pandemic reviving the Pharma industry? Must Read

Major oil & gas companies, retail, industrial and energy players have been hit hard during the virus crisis.

Thus, several companies are at a risk of being pushed out with the supervisors wondering over the degree of permanence of the impacts of COVID-19. They are adopting a wait and see approach and removing major companies from an index widely followed worldwide, which might lead to a chain of reaction.

One, an intensive index rebalancing is going to exert pressure on the eliminated companies that are already struggling with liquidity and operational halts. Furthermore, the market is flooded with Exchange Traded Funds (ETFs) that provide exposure to these companies that maybe the potential eliminations. Thus, a drastic rebalancing would create a market disturbance and these stocks would further face pressure from the technical selling and even more deceleration in the stock price.

What adds to the inhibitions of the makers of the S&P500 is what if this slowdown turns out to be temporary and these companies do actually recover.

Some market experts are estimating that around 30 companies maybe be deleted from the index, but the subsequent difficult task would be which firms to add to the index, given the relentless impact of COVID-19 and market volatility.

As per the eligibility criteria, a company must have at least $ 8.2 billion of market capitalisation with sufficient liquidity measures in place. Additionally, the business needs to have recorded profits in the most recent quarter and positive earnings in the past four quarters.

It is true that market capitalisation standards are viewed on a regular basis to ensure consistency with market conditions. Nevertheless, while travel, airline and hospitality companies rarely have a chance, high concentration of technology centric and health companies poses a challenge to not add any more stocks from these industries. This is because S&P 500 is currently an inadequate reflection of the global economic downturn and already skewed towards mega-cap companies that no doubt have kept the investor sentiment floating.

Read: 3 Countries leading the COVID-19 race: Key takeaway for the others

 


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