At this year’s Basis Northwest conference, indexing veteran Rob Arnott, Founder and Chairman of Research Affiliates, sat down with ETF.com’s Dave Nadig for a candid, wide-ranging conversation that touched on one of the most anticipated financial events in years: the SpaceX IPO. What started as a discussion about index mechanics quickly turned into a meditation on bubbles, valuation, and the structural pressures that passive investing has built up and may be about to unleash.
The Tesla Lesson Nobody Learned
To understand why SpaceX’s market debut matters so much, it’s vital to look back at Tesla. When S&P Dow Jones finally added Tesla to the S&P 500 in late 2020, after waiting for four consecutive profitable quarters, the stock had already surged more than 500% from the moment investors realized it was inevitable. The 50% pop on the actual announcement week was the part everyone remembered. The preceding 450% was the part everyone forgot. The lesson the index industry drew from this was the importance of not being late, of moving faster, which is exactly the mindset that now has everyone scrambling over SpaceX.
The central mechanical issue Arnott raised is the SpaceX float. The company is expected to IPO with only about 4% of its shares available to trade. Let’s imagine that S&P decides to include it at its full market capitalization. Index funds tracking the S&P would theoretically need to own around 25% of the total company, but only 4% of it exists in the market. Over the months following the IPO, as lockup schedules expire and more shares become available, there will be a steady and growing wave of valuation-indifferent demand, or buyers who don’t care what they’re paying because they’re just replicating an index.
Index funds, by design, don’t ask whether a stock is cheap or expensive. Instead, they simply buy because it’s in the index, and they buy in proportion to its weight. When a stock like SpaceX enters with a tiny float and a massive implied valuation, there will be huge demand chasing a tiny supply, for reasons that have nothing to do with business fundamentals. Compounding concerns is the role the options market will play. With a tiny float and parabolic momentum, retail investors will pile into calls and puts on SpaceX from day one. Zero-day-expiration options trading has already shown what happens when implied leverage amplifies demand beyond the underlying shares available.
Once the valuation-indifferent demand slows and indexes are fully loaded and lockup shares are all in circulation, the artificial floor disappears. What remains is a stock priced at 100-plus times sales that has to justify itself on fundamentals. Arnott’s scenario is one where SpaceX runs to $10 trillion in market cap (from roughly $2 trillion at IPO), reaches 700 times sales, and then the demand evaporates. Arnott’s practical advice for anyone who wants to play the SpaceX trade is to buy as much as you can get in the IPO, trim gradually with each index inclusion, and only commit a monetary amount you’d be ok losing completely.