Macy's is the first of what could be a retail and energy purge from the S&P 500

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The entrance to a Macy’s department store.

Jeffrey Greenberg | Universal Images Group | Getty Images

Macy’s is being dropped from the S&P 500, and in a sign of how far the fortunes of the retail space have fallen amid the coronavirus-related shutdowns, it is not being demoted to the mid-cap S&P 400, it’s being sent all the way down to the small-cap S&P 600.

It will likely not be the last company to suffer such humiliation.

Macy’s will be dropped from the S&P 500 on Friday to be replaced by Carrier Global, which is being spun out of United Technologies after United merges with Raytheon.

S&P’s decision to kick Macy’s out of the big-cap index is certainly understandable. Macy’s has dropped from a market capitalization of roughly $6 billion in mid-February to $1.5 billion today.

“Macy’s has a market capitalization more representative of the small-cap market space,” S&P Dow Jones Indices, which manages the S&P 500, said in a terse statement.

The problem is, Macy’s has plenty of company.  Kohl’s, Nordstrom, Gap and Hanesbrands all have market caps in the $2 billion range.

So do plenty of energy companies, such as Apache, Devon, and Marathon Oil.

Could there be a purge of retailers and energy companies from the big-cap rankings?

Howard Silverblatt, senior index analyst for Standard and Poor’s S&P Dow Jones Indices, sees a purge as possible. 

“That would essentially be saying that retailers, with a few exceptions like Walmart, are no longer big-cap companies,” he said.

Who decides what goes in and out of the S&P 500?

The components of the S&P 500 are selected by the index committee for the S&P 500, which meets monthly. 

Unlike the Russell 2000, which is strictly rules-based, the S&P indexes and the Dow Jones Industrial Average are not based on strict guidelines.  “Constituent selection is at the discretion of the Index Committee and is based on the eligibility criteria,” S&P says. 

The criteria for inclusion include domicile (U.S. companies), liquidity (dollar-value traded), and financial viability.  Market capitalization guidelines are also a factor, and here S&P is very explicit on how big a company needs to be to be included in one of the three major indices:

Market capitalization eligibility:

  • S&P 500: $8.2 billion or more
  • Midcap 400:  $2.4 billion to $8.2 billion
  • Small cap 600:  $600 million to $2.4 billion.

 Source:  S&P Indices

Some groups are likely to see diminished representation in the S&P 500

Judged solely by market capitalization, many companies in the S&P 500 appear in danger of being kicked out.  About 100 companies in the S&P 500 have market caps at or below $8.2 billion and so are technically mid caps; fourteen are already in small-cap territory.

But that does not necessarily mean that the companies will be kicked out immediately.

“Putting in is one criteria, but taking out is a different issue,” Silverblatt said. 

“You can fall way down in market value but it won’t necessarily get thrown out just because of that.  More typical is that it no longer represents the group it is in, or the group as a whole just isn’t a big-cap group anymore.”

He added there would be ample precedent for that, pointing to publishers, whose share prices collapsed a decade ago.  The New York Times, for example, was taken out of the S&P 500 and put into the Midcap 400 in December 2010. 

“Publishers were no longer a big cap group,” Silverblatt said.  Gannett and Washington Post were both in the S&P 500 and were subsequently removed.

Another point:  The criteria for what constitutes small-, mid- and big-caps can and does change.  The most recent changes were effective on Feb. 20, 2019, but it is quite possible S&P could change again.

Another issue is what to replace them with?

Silverblatt noted that the S&P 500 still needs to reflect what the market cap of the overall big-cap market is.  “What other areas do you need representation in?” he asked.  “Where am I underweighted?  Do you need to add health care, for example?”

We’re all indexers: Why it matters what groups go in and out of the S&P 500

Many investors own index funds like the S&P 500.  As these funds drop stocks or even whole groups of stocks in some sectors, like retail and energy, passive investors will own less of these groups.  Energy is already only about 3% of the market cap of the entire S&P 500.

That means the S&P 500 will become even more concentrated in certain sectors, said Andrew McOrmond, managing director at WallachBeth: “The weightings of certain sectors will become underweight and the SPY (S&P 500) is a cap weighted index.  It is very tech heavy now and will continue to be that way.”

So is this the end for energy and out-of-favor retailers?  Maybe for passive investors, but not active investors, McOrmond says:  “This is when active management will have a chance” against the passive investors, noting that they will be able to look for opportunities and tactically buy out-of-favor sectors.

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