Bending the Index Rules: SpaceX, OpenAI, and Anthropic's Unconventional Leap into S&P 500

Here's the thing: the S&P 500, a traditional bastion of American industry, is about to make an unconventional leap. SpaceX, OpenAI, and Anthropic are set to enter the index even though they don't meet its long-standing profitability requirements. It feels like rewriting the rules of the game.

Why Profitability Isn't What It Used to Be

Traditionally, the S&P 500 required companies to show positive earnings over four quarters. This wasn't just a formality. It was a safeguard ensuring only profitable giants could sway the index. Remember Tesla? Despite its massive valuation, it sat outside the S&P 500 until the end of 2020 because it hadn't turned a profit.

But now, SpaceX, OpenAI, and Anthropic are set to break this mold. SpaceX reportedly lost billions last year, and neither OpenAI nor Anthropic is in the black. Yet, they're all predicted to rank among the largest U.S. companies and quickly dominate many 401Ks and index funds once they go public.

Why the change? In April, S&P Dow Jones Indices opened a consultation on how to handle MegaCap companies, those with market capitalizations over $112 billion. The proposed changes? Waive the profitability test for these titans, shorten the public trading requirement from 12 to 6 months, and reconsider the float requirement.

The Risks of Fast-Tracking Giants

So, what's the catch? These rules were designed with investors' protection in mind. The profitability rule ensured only stable companies joined the ranks. The seasoning period allowed stock prices to stabilize post-IPO, reducing volatility risks for investors. And the float rule guaranteed that shares were actually available for trading, rather than locked up.

SpaceX, the largest of the trio, plans to float just 5% of its stock, keeping the rest locked up. At a valuation of around $1.75 trillion, that's a lot of weight on a tiny slice. Can the market handle such pressure when passive funds rush to buy?

Here's a thought: if these companies stumble, can they still serve as reliable bedrocks of investor portfolios? After all, passive funds that mirror indices don't have the luxury of picking and choosing.

Investor Expectations and the Crypto Parallel

The impact on investors could be massive. With approximately $20 trillion indexed or benchmarked to the S&P 500 by December 2024, the forced buying that would ensue following these fast-tracked inclusions could unleash waves of demand.

Goldman Sachs analysts previously estimated up to $60 billion could be forced into buying when Nasdaq adopted a similar fast entry rule. That's just a taste compared to the S&P 500's vast pool of funds.

In a world where crypto adoption doesn't resemble a VC pitch deck, this is a familiar story. The space is all too acquainted with volatile valuation and investor speculation. The difference? Cryptos often act as inflation hedges or remittance corridors, offering tangible value even when market behavior is unpredictable.

The New Normal or a Risky Gamble?

So, what's the verdict? If these changes hold, we're witnessing a shift towards valuing market dominance over traditional profitability. That's a gamble. But it's a gamble with potential payoffs for investors willing to ride the waves.

But will large institutional holders accept this? Some, like Nell Minow, suggest otherwise. She predicts that major retirement funds might demand indices that exclude these companies, preserving the integrity of their investments. After all, indexes were built to simplify choices by curating solid options, not by bending the rules.

In the end, it's a high-stakes game. As these companies look to redefine the S&P, the real question is: Are they the future of stable investments, or are we on the brink of a new era of market volatility?