Nasdaq Is Reducing the Influence of Giant Tech Firms in a Popular Stock Market Index
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In another sign of big tech's stock market domination, Nasdaq is giving a popular index a new look — one intended to reduce the influence giants like Apple and Microsoft have on the index overall.
As the name implies, the Nasdaq 100 index is made up of 100 of the largest Nasdaq-listed, non-financial companies. While it may not get as much attention as the Nasdaq Composite — which, alongside the S&P 500 and the Dow Jones Industrial Average, is one of the most-followed benchmarks for the U.S. stock market — the Nasdaq 100 gets tracked by a slew of funds. They include the Invesco QQQ Trust, the world’s fifth-largest exchange-traded fund (ETF), according to Morningstar.
The Nasdaq 100 is often used as a proxy for growth stocks, or stocks of companies that are expected to grow at a faster rate than the market overall. So far this year, it has soared about 46% compared to the S&P 500's 19% jump.
This comes as the boom in interest around artificial intelligence has pushed stocks dubbed the "magnificent seven" — Apple, Microsoft, Nvidia, Amazon, Meta, Tesla and Alphabet — to eye-popping figures. As of Wednesday, Microsoft's stock was up about 50% for the year and Apple's, 56%, making up a whopping 13% and 12%, respectively, of the aforementioned Invesco fund.
That's about to change.
What is a special rebalance?
Earlier this month, Nasdaq announced in a news release that the Nasdaq 100 index will undergo a "special rebalance" that will come into effect when the market opens Monday. The index is typically rebalanced each quarter, but outside of that it can employ a special rebalance "to address overconcentration in the index by redistributing the weights," according to the release.
While we don't yet know exactly what those changes will be, the index's methodology says that it can be adjusted if companies with weightings that exceed 4.5% of the index together make up more than 48% of the index.
"Given the special rebalancing doesn’t occur too often, it says a lot about the historic nature of the rally in those half-dozen or so names relative to the rest of the Nasdaq 100," says Dave Grecsek, managing director in investment strategy and research at Aspiriant.
What the Nasdaq 100 special rebalance says about tech stocks
Tech stocks have been on a tear this year and were a significant driver of stocks entering a new bull market last month.
The Nasdaq 100's special rebalance is yet another data point that shows just how strong a small group of stocks has performed in 2023, says Matthew Stith, manager of equity research at Bartlett Wealth Management. While he adds that it doesn't necessarily indicate that tech has too much control of the market, it does highlight the attractiveness of these businesses and compelling investment opportunities relative to other areas.
"Some of this is also a reversal of the tech sell-off that we witnessed in 2022," Stith says. "From a fundamental perspective, things didn’t get as difficult for these leading tech companies as many predicted."
The result has been increased investor attention and enthusiasm for tech stocks now — at the expense of other sectors, he says.
Grecsek says that these tech stocks' high valuations means it's probably not the best time to be chasing mega-cap tech names or even the tech sector overall.
Keep in mind that financial advisors tend to recommend having a diversified portfolio that aligns with your goals, time horizon and risk tolerance.
For portfolios that are over-allocated to tech, now would be a great time to lower that exposure — as in, sell off some tech and reinvest in areas of the market that haven't rallied as strongly, like value stocks (that appear to trading at a lower price than their actual value) and international stocks, Grecsek says.
Will the special rebalance impact me?
Stith says a big concern — and what's driving this rebalance — is the diversification risk associated with indexes that are dominated by a small group of stocks.
"Strategies that follow a benchmark like the Nasdaq 100 are often appealing to investors as they provide a diversified way to get exposure to many different areas within technology," Stith says. "When the index gets dominated by a small group of companies, investors lose this diversification, which can unknowingly create risk that they are trying to avoid."
So how will this change affect you?
"Investors of funds tracking the Nasdaq 100 Index will wake up on July 24 with a different portfolio," Bryan Armour, director of passive strategies research for North America at Morningstar, wrote recently.
He says the differences won't be vast, but there could be some trading costs the portfolios have to pay, which could weigh on performance a bit, and that funds could be hit with a tax bill from selling stocks that have soared.
"Most investors in U.S. stocks will be at least indirectly affected by the rebalance," Armour added. That's because "billions of dollars of stock" will be traded as funds tracking the Nasdaq 100 buy and sell in response to the rebalancing.
The price impact on the stocks themselves will likely be limited, since the selling will be within very liquid stocks, but "markets may experience a bit higher volatility as the changes become known and the market repositions," Armour said.
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