Say you’re a public company in the S&P 500. How’s your stock doing?
For every CIEN and SNDK, there are three components trailing the benchmark, says the math. On average, 72% of S&P 500 stocks the past three years lagged the index.
Why?
Let me tell you a story – since we’re just back from sailing and staying on St Barts. Karen is cool enough for St Barth, as it’s called, but I had to crawl in through a culvert. It’s where the cool kids go. See trip photos here.
Awesome place but economically you’re stacking currency and setting it afire.
Which brings me to my story. In St Martin and St Barth, euros and dollars are interchangeable. It matters because both islands are, technically, Europe. You’re either in France or the Netherlands.
Which by the way is great for provisioning boats. You get French food, French culinary expertise, French wine.
But if you’ve been to Europe lately you know a buck buys about 85% of a euro. Sure, dollars and EC – East Caribbean dollars – have long been two-to-one convertible. Same in Belize (basically the diametric opposite of St Barth).
If you’re in a taxi and the driver will take twenty euros or twenty bucks, offer Jacksons. You’re making 15% on the trade. Maybe it’s convenient? I don’t know about you, but I won’t give up 15% as a convenience fee.
So it means the islands value the two the same.
And that is new.
We’ve been to these islands several times before. Never have I seen widespread rejection of official exchange rates. It’s like everybody knows that what’s face value is wrong.
What’s this got to do with the S&P 500?
The S&P 500 is like two currencies: There’s the index’s performance tracked by ETFs like IVV, VOO, SPY. And there’s the basket of stocks. Officially, they’re the same.
But they’re not. One is trading at a gigantic discount.
Take the average price of those 500 stocks, currently about $225, and it’s up about 12% the past year, which reflects the soaring rise from the Tariff Tantrum in April a year ago.
But SPY is up nearly 29%, more than double the basket underpinning it. It’s not weighting. The equal-weight ETF, RSP, is up about 22% over the same period.
We’re tallying all the prices of the components and dividing by total components to get $225.
The giant spread between SPY and the average price of the basket wasn’t there a year ago. It formed in May 2025 and widened to a zenith in October 2025 before the market stalled and fell.
In this cataclysmic recent rebound wiping out any evidence of war, it’s now the widest ever.
What’s going on? Biased selection. The same reason TEAM was booted from the Nasdaq 100 and replaced with SNDK. Indexes favor the favored and scorn the scorned.
Okay, does it matter?
It’s good for index investors. But it’s bad news for investors in individual stocks. And for public companies, which might be added to an index expecting built-in demand.
Getting into an index is half the battle. The real coup is getting into the BASKET that SPY et al use. And that basket is small. It’s the only conclusion when can draw honestly from the data.
What that means is the stock market reflects a handful of outperforming stocks, whose outsized influence through ETFs and options and futures inflates the market.
It’s like wildly divergent spot oil and futures prices, as Jinjoo Lee wrote in the WSJ (subscription required).
It’s like valuing euros and dollars the same. On the surface, in the headlines, dollars and euros are worth different amounts. On the streets of St Martin, they’re the same.
On the surface, the S&P 500 reflects the value of components. At the street level, it doesn’t. Maybe you’re in the 30% that beats it. And maybe you’re in the 70% that doesn’t.
The cause? Investors buy ETFs rather than stocks. The sponsors of ETFs choose which stocks they’ll take as “collateral” to back ETF shares. Like taking SNDK, CIEN, and rejecting TEAM (and the entire Software industry) or WDAY.
The problem with that is easy to understand. Any part of the market could be scorned and disfavored like Software, because ETFs control the basket. They determine what’s favored, what isn’t.
And that means your financial performance doesn’t. Oh, fundamentals matter! You need profits and liquidity and size to join the S&P 500. But ETFs, not the index, dispense scorn and favor.
The lesson? You can’t trust the market to give you accurate prices, correct reflections. Just like you can’t take the exchange rate of euros and dollars at face value. Use a taxi driver for that.
Investors, you better understand Demand and Supply (sign up for free EDGE daily notes).
Public companies, the market is excluding the many and favoring the few. You must have a strategy for this market. The starting point is understanding what’s going on. We know.
