A Simple Lesson On How the S&P 500 Works - the AP Has No Clue

I came across this disaster of a story from the Associated Press just now:

"Apple May Surpass Exxon As Most Valuable Company."

Interesting - Apple is a monster - but I didn't expect the AP (that's Associated Press, not to be confused with AAPL) to attempt to mis-educate their vast audience with this blatantly false nonsense that shows a thorough lack of understanding of how the SPX works:

"While Apple CEO Steve Jobs will no doubt be happy about his new perch atop the business world, there's more at stake here than mere bragging rights. As soon as the total value of the company's shares edges above Exxon's, Apple will take over the top spot in the Standard and Poor's 500, the market index used by most professional money managers.

That means that billions of dollars invested in funds that track the index will have to shift their holdings to reflect Apple's new weighting. Exxon, meanwhile, may see its share price fall from the same effect. That slide could be accelerated by hedge funds and technical traders who make bets based on the rebalancing of major indexes and would be primed to short the shares of Exxon."

Reminder:  The S&P 500 is a market cap weighted index.  That means that larger companies have a higher weight in the index.  An S&P 500 index fund will own a certain percentage of the outstanding shares of each company.  It doesn't take a market expert to understand that when Apple's share price rises, and its market cap rises, its value in your S&P 500 portfolio also rises!  As an S&P indexer, you don't have to do a thing.  Changes in market cap based on share price movement are automatically self adjusting - after all, market cap  = share price x shares outstanding.

On a quarterly basis, the S&P 500 rebalances its index based on new share issuance and buybacks (in other words, changes in shares outstanding).  For example, when XOM buys back shares, S&P 500 indexers will need to sell shares of XOM.  If XOM does a secondary offering, indexers will need to buy shares of XOM. 

Price movements do not create the need for S&P 500 indexers to rebalance their portfolios.

Score another one for mass market media miseducating their minions.

-KD