Index Investing Makes the S&P 500 Something Less Than a Benchmark
I don't own a single share of Shawmut National Corp., but I made $1,700 in two days last week because Shawmut was gobbled up in a merger. How did I make money on a stock I've never owned? Easy. One of my biggest investments, Comerica Inc., was picked to take Shawmut's place in the Standard & Poor's 500-stock index, and indexers began buying truckloads of Comerica shares. That produced a windfall for those of us who owned the stock.</br></br>Welcome to the wonderful world of indexing. S&P announced last Tuesday evening that Comerica was joining the S&P 500. Comerica officially joined the index when the stock market closed on Thursday. By then, its stock had risen $2.12 1/2, a nice 6 percent jump from its Tuesday close. My 800 Comerica shares -- the biggest single holding in my retirement accounts -- were thus worth $1,700 more than they were two days earlier. In all, Comerica's shares gained about a quarter-billion dollars in market value.</br></br>Had Comerica's prospects improved? Were its profits higher? Had some divine power alleviated the problems wracking Detroit, Comerica's hometown and biggest single market?</br></br>Nope. By all accounts, the two-day increase stems entirely from Comerica becoming part of the index. That forced index funds and other investors with portfolios tied to the S&P 500 to buy Comerica. All these new buyers -- a total of 6.3 million shares changed hands Wednesday and Thursday, more than 15 times Comerica's normal daily trading volume -- levitated the stock. From now on, Comerica stock will be about $2 higher than it would be without the indexers. So I'm ahead even though I haven't sold my shares.</br></br>I'm not telling you this tale to brag; it's not as if I knew Comerica would go on the S&P 500. Rather, I want to discuss how Comerica -- pronounced Koh-MEH-rikka -- is a teeny-tiny example of how index investors can distort the prices of individual stocks. And how the S&P 500, the benchmark by which most professional investors judge their performance, is becoming distorted.