The S&P 500 Curse: Why New Entrants Often Stumble And Underperform

#Historical Data: From Excitement to Disappointment

Let's start with the numbers. Historically, companies entering the S&P 500 often enjoy a short-term boost, but that excitement doesn't always translate to sustained success. According to a study by Nasdaq, stocks entering the index tend to see an initial jump as index funds and ETFs scramble to buy shares. However, that gain can quickly fade as overvaluation concerns, rising expectations, and economic pressures take their toll​.

Take Tesla ($TSLA), which was added to the S&P 500 in December 2020 amidst much fanfare. The stock surged in the days leading up to its inclusion, with Tesla's price nearly doubling in anticipation. But by the end of 2021, Tesla's stock performance had leveled out, even underperforming against its incredible pre-inclusion rally. Despite Tesla's broader success, it struggled to live up to the lofty post-inclusion expectations as investor enthusiasm tempered​.

Another sobering example is Twitter ($TWTR), yet has been taken private and known as X), which joined the S&P 500 in 2018. While the stock initially surged on the news, the next 12 months weren't as kind. Twitter's stock price fell by about 30% after joining the index, facing challenges like increased competition, stagnant user growth, and growing operational costs. By the time Elon Musk took over the company years later, its performance had already left many investors frustrated, showing that entry into the S&P 500 doesn't shield a company from its existing challenges.

In 2021, Moderna ($MRNA), riding high on its vaccine success, joined the index with a lot of optimism. However, its performance faltered in the subsequent 12 months, with the stock losing over 60% of its value from its post-induction highs. As the world moved on from the pandemic-driven demand for vaccines, investors quickly realized that Moderna's growth trajectory wasn't as explosive as it had been in the height of the crisis​.

#The Valuation Trap: Flying Too Close to the Sun

So why do companies tend to struggle after joining the S&P 500? One key reason is valuation inflation. Many companies that join the index do so at the peak of their growth cycle. By the time they're included, their stock price may have already factored in much of the growth potential, leaving little room for further upward movement. And as the saying goes, "What goes up must come down."

Let's look at Etsy ($ETSY), the online marketplace known for handcrafted goods. Etsy joined the S&P 500 in March 2021, following a surge in online shopping during the pandemic. Its stock skyrocketed as consumers embraced e-commerce, but once pandemic-related tailwinds faded, so did Etsy's stock performance. In the year following its inclusion, Etsy's stock lost around 40% as the company struggled to maintain the same level of growth. The market had simply overvalued its potential.

ViacomCBS (now Paramount Global, $PARA) is another example of a company that stumbled after its entry into the S&P 500. Added in December 2019, ViacomCBS initially saw a stock boost. However, within a year, the stock dropped over 50%. A combination of industry headwinds, increased competition in streaming, and broader market volatility contributed to its poor performance. Despite being a media giant, ViacomCBS faced a brutal market correction that reminded investors that bigger isn't always better.

Intel ($INTC), which re-entered the S&P 500 in the early 2000s after a brief exit, also struggled post-inclusion. In the first year after its return, Intel's stock faltered as the tech bubble burst, illustrating that not even giants of industry are immune to the "S&P curse." Over the years, Intel has continued to battle increased competition from rivals like AMD, leaving its stock performance choppy at best in the years following its re-induction.

#Sector Sensitivity: Tech and Consumer Discretionary Oftentimes Take the Hit

Not all sectors are equally vulnerable to the S&P 500 underperformance trap. Tech companies and consumer discretionary firms, in particular, are among the most susceptible to sharp post-inclusion drops. These sectors often experience rapid growth that attracts attention—and inflated stock prices—right before joining the index. However, when that growth slows or macroeconomic factors change, these companies are hit hard.

In 2022, the tech sector saw a brutal 27.21% year-to-date decline, highlighting how quickly the tides can turn for these high-growth darlings. Match Group ($MTCH), which joined the S&P 500 in 2020, initially benefitted from a surge in user growth during the pandemic. Yet, as the world moved on from lockdowns, Match's stock lost nearly 50% in the year following its induction, showing that love (or in this case, dating apps) doesn't always last forever​.

Now, enter Palantir ($PLTR), the latest tech stock to join the S&P 500 as of September 23, 2024. Known for its secretive software used by government agencies and corporations alike, Palantir has long been the subject of fascination and fervor among its loyal fans. But as history has shown us, not even Big Data can save a company from the dreaded S&P 500 entry curse. After an impressive 135% rise in the year leading up to its inclusion, investors may be in for a wild ride​.

Of course, Palantir's die-hard fans will argue that this company is different, destined to break the mold. But remember, even The Matrix had sequels that couldn't quite live up to the original. So while Palantir might appear bulletproof right now, its biggest challenge may come from the heightened expectations of being in the S&P 500 spotlight. Let's just hope that for Palantir's sake, the stock doesn't become a "ghost in the machine" post-inclusion.

#A One-Way Ticket to Underperformance?

Joining the S&P 500 is no small feat. It's a marker of success, a badge of honor that signifies a company's arrival on the big stage. But as we've seen, the stock market doesn't necessarily reward these newly minted members with continued success. In fact, joining the index might be the peak of the ride, with many companies struggling to maintain their momentum once the institutional buying frenzy cools off.

From Tesla to Etsy to Moderna, the pattern is clear: companies that join the S&P 500 are more likely to experience disappointment than sustained growth in the months following their induction. Investors should tread carefully when a company joins the index, as history suggests that the hype often overshadows the reality.