The seemingly unstoppable growth of megacaps like Apple and Microsoft mean they have breached an upper limit imposed on stocks in the Nasdaq 100. As a result, Nasdaq has announced a “special rebalance” – the first ever of its kind – will be carried out to redistribute the weight of the index’s members.
The index provider says the July 24 adjustment will “address overconcentration in the index by redistributing the weights,” according to a statement from the firm on Friday, with more details due later this week.
Nasdaq’s extraordinary action is a result of the relentless rally that has accounted for almost all the broader market’s gains in 2023. Fueled by optimism over artificial intelligence, the supercharged performance has sparked a heated debate on Wall Street about whether this top-heavy advance can last.
It’s “a good thing as it reduces the concentration risk from those players,” said Todd Sohn, managing director of ETF and technical strategy at Strategas Securities. “On the other hand, it increases the burden for the rest of the index – what I like to call ‘the bench’ – to continue to improve and strengthen.”
While details on the action are sparse, a paper on the Nasdaq website says special rebalancings can be called in certain circumstances when the portion represented by the index’s biggest members exceeds a preset threshold. In one scenario, the document says, weights can be pared back if the combined influence of the largest companies – those making up 4.5% or more of the gauge – adds up to more than 48%.
Data compiled by Bloomberg show that was the case on July 3, when six companies – Microsoft, Apple, Alphabet, Nvidia, Amazon.com, and Tesla – saw their combined weight reach 50.9%. The Nasdaq methodology paper says a rebalancing may be enacted to reduce the group’s influence to 40%.The rebalance is intended to help fund managers who are linked or benchmarked to the Nasdaq 100 to stay in compliance with a Securities and Exchange Commission diversification rule that limits the aggregate weight of the largest stock holdings, those with a 5% representation or greater, to 50%, according to Cameron Lilja, vice president and global head of index product and operations at Nasdaq.
“From our perspective, the motivation to reduce index concentration is purely from the regulatory angle,” he said.
All the stocks in that group fell on Monday, with shares of Alphabet and Amazon dropping more than 2%. The traditional version of the Nasdaq 100 was flat, while the one that strips out market cap bias climbed 1.8%. It’s a drastic reversal from the previous six months, when the equal-weight index trailed by 18 percentage points.
“Megacap tech is underperforming today on the rebalance announcement,” said Alon Rosin, Oppenheimer & Co.’s head of institutional equity derivatives. “They all got hammered relatively as we are seeing money rotations elsewhere.”
While the biggest firms will have their sway trimmed, and index-tracking funds such as Invesco QQQ Trust will need to tweak holdings, the reshuffling is unlikely to by itself cause profound changes to the Nasdaq’s performance going forward.