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Many Changes in S&P; 500 Raise Scrutiny of Tech Focus

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TIMES STAFF WRITER

For the caretakers of major stock market indexes, these are testing times.

With share prices wildly volatile, the economy downshifting and investor capital lurching from sector to sector, it is tricky deciding which stocks are most representative of the market--and thus most deserving of inclusion in closely watched indexes.

Standard & Poor’s Corp.’s 500-stock index, arguably the world’s most important single market barometer, has undergone a record number of changes in the last year, adding a number of fast-growing technology companies and ushering out some once-mighty industrials.

The 30-stock Dow Jones industrial average, which still is what many people mean when they say “the market,” has at least one stock substitution, and perhaps a handful, on the horizon.

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Changes in these indexes are of more than academic interest, of course. The S&P; 500 has an estimated $1 trillion in investors’ dollars linked to it via index mutual funds and instruments such as SPDRs--S&P; depositary receipts, which are index funds that trade like individual shares on the American Stock Exchange.

What’s more, the S&P; 500’s performance is widely used as the benchmark that active money managers are judged against.

Dow Jones & Co. came late to the index licensing game, but its flagship index, too, now can be purchased as a whole via financial instruments such as the Diamonds Trust Series, which like SPDRs trade on the Amex.

With the S&P; 500 and the Dow in 2000 suffering their worst calendar-year price declines since at least 1981--the S&P; fell 10.1%, the Dow 6.2%--the composition of these indexes, and how their stocks are chosen, are topics that may well get more scrutiny in the new year.

In the case of the Nasdaq composite index, there is no design involved: That index includes all the 4,200 Nasdaq-listed stocks.

But the Dow and the S&P; 500 are designed. Technology has in recent years become the single largest stock sector in the S&P; 500, in part because of the surge in those stocks overall, but also because S&P; has added more tech names to the index.

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That raises the question: Could the S&P;’s stock pickers have made tech too dominant in the index, in an effort to boost its performance?

The guardians of the S&P; 500 have long insisted that their goal is to make the index representative of the market and the economy--not to try to pick the stocks that will perform best.

David M. Blitzer, S&P;’s chief strategist and the head of the committee that picks index stocks, said the panel tries its best to have each of 11 major industry sectors within the S&P; 500 match its weighting within the broader market.

To get an idea of a sector’s overall representation in the economy, the panel examines thousands of stocks too small for the S&P; 500, Blitzer said. This research can help alert S&P; to developing trends--such as technology’s growing importance in recent years.

Typically, stocks “bubble up” through the ranks of the S&P; small-cap 600 and mid-cap 400 indexes before becoming candidates for the blue-chip 500 index.

Not all big-capitalization stocks are candidates, however. Blitzer said he has opposed adding Amazon.com to the S&P; 500, for example, because he feels that companies not yet profitable don’t belong in the index.

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Stephen Sanborn, director of research at Value Line Asset Management, said that when he held a similar position at Standard & Poor’s, the philosophy “was always that you don’t jump on the bandwagon with something until you’re sure it’s going to last.”

Whether or not strong performance also is the index designers’ goal, there is little doubt that the rising weight of tech stocks in the S&P; 500 helped it outgain the less-tech-heavy Dow--220% to 200%--during the last five years of the 1990s.

By the same token, the tech collapse of 2000 inflicted more damage on the S&P; 500 than on the Dow.

But even as tech shares plunged last year, S&P; continued to add more issues from that sector to the index, suggesting faith on the part of the S&P; pickers in the long-term staying power of tech.

S&P; made a record 59 stock changes in the S&P; 500 last year, with a record 22 of the new stocks coming from the tech sector.

In December alone, S&P; added such beaten-down tech shares as Vitesse Semiconductor, QLogic and Intuit to the index.

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In 1999 there were 41 substitutions within the S&P; 500, of which 11 were tech stocks.

Substitutions can occur at S&P;’s whim, or because stocks in the index are disappearing because of a takeover or bankruptcy.

The S&P; index, unlike the Dow, is weighted by market capitalization, which is a company’s stock price times shares outstanding. Thus, a half-point move by a whale such as Microsoft or General Electric moves the S&P; more than a multiple-point gain or drop by a relative minnow.

The Dow, by contrast, is price-weighted. So a 1-point gain by Microsoft moves the index no more and no less than a 1-point gain by much smaller Eastman Kodak.

The S&P;’s market-capitalization weighting system means that the importance of different industries in the index isn’t purely a function of which stocks S&P; adds or subtracts. As companies rise and fall in the marketplace, their capitalization--and S&P; 500 weighting--shifts automatically.

So even without any component changes, tech would have become a bigger factor in the S&P; index during the 1990s, just as energy became a bigger factor in the index in the late-1970s.

As recently as June 1994, tech stocks accounted for less than 10% of the S&P; 500’s capitalization. By the end of 1997, tech’s weighting had risen to 13.3%.

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With the tech-stock mania that began around December 1998, the sector’s weighting in the S&P; more than doubled, to 29.9%, by the end of 1999.

The peak came in the second week of last March, when tech reached 35% of the index’s capitalization.

In the aftermath of the plunge in most tech shares since March, the sector’s weighting in the S&P; 500 is now 21.9%, according to Bloomberg News data. But that still makes tech by far the largest industry represented in the index.

If the S&P; seems even more tech-heavy than those numbers indicate, it may be because many stocks commonly considered techs--telecommunication firms and electrical-equipment manufacturers, to name two--aren’t defined that way by S&P.;

Jabil Circuit, for example, slated to join the S&P; 500 early this year, makes electronic circuit boards for computers, communications equipment and other uses. But S&P; classifies it as a capital-goods stock, not a tech.

Could the S&P; now have “too much” tech? That may only become evident in retrospect, of course.

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But investors in S&P; index funds who fear their performance could suffer if tech continues to slide should note that the index’s sector weightings are ultimately self-correcting: If investors favor other sectors over tech for the next few years, those sectors will grow in importance within the index while tech fades.

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Thomas S. Mulligan can be reached at thomas.mulligan@latimes.com.

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Here are the current market capitalization weightings of the 11 major industry sectors within the Standard & Poor’s 500 index, as calculated by Bloomberg News. Technology is the largest sector, while transportation stocks make up the smallest industry sector.

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Technology: 21.9%

Financials: 17.3

Health care: 14.0

Consumer staples: 11.3

Capital goods: 9.0

Consumer cyclicals: 7.6

Energy: 6.4

Communications: 5.5

Utilities: 3.9

Basic materials: 2.4

Transportation: 0.7

Source: Bloomberg News

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A Sampling of S&P; Changes in 2000

Here are some of the technology stocks added to the Standard & Poor’s 500 index in 2000, and the stocks they replaced. Many of the stocks kicked out were the targets of takeovers.

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Date In Out 1/28/2000 Conexant Systems Consolidated Natural Gas 3/31/2000 Veritas Software Pep Boys 4/17/2000 Altera Atlantic Richfield 5/04/2000 Siebel Systems CBS 6/02/2000 Agilent Technologies NACCO Industries 6/30/2000 Broadcom GTE 12/08/2000 Intuit Bethlehem Steel 12/29/2000 Applied Micro Circuits J.P. Morgan

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Source: Standard & Poor’s Corp.

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The S&P; 500 Got a Makeover ...

Standard & Poor’s Corp. changed 59 of the stocks in its blue-chip 500 index last year, the largest number of substitutions ever.

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Number of stock changes in S&P; 500 index

2000: 59 changes

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... And Was Roiled by Its Tech Weighting

Technology stocks’ share of the S&P; 500’s market capitalization soared in 1999, then dived in 2000. Tech still is the index’s largest sector weighting.

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Percentage of the S&P; 500 index capitalization in technology stocks, end of each quarter

Fourth quarter 2000: 21.9%

Source: Standard & Poor’s Corp.

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