It may be the biggest stock story of 2023: a small number of giant tech companies are now a very large part of major indexes like the S&P 500 and the Nasdaq-100.
Five companies (Apple, Microsoft, Amazon, Nvidia And Alphabet) make up about 25% of the S&P 500. Six companies (Apple, Microsoft, Amazon, Nvidia, Alphabet and Broadcom) make up approximately 40% of the Nasdaq-100.
The S&P 500 and Nasdaq will rebalance their respective indexes this Friday. Although this is a routine event, some changes may reflect concerns about concentration risk.
A lot of money is tied to a few indexes
With the CPI and Fed meeting behind us, these rebalances are the last major “liquidity events” of the year, aligning with another notable trading event: triple witching, or the quarterly expiration of stock options, index options, and index options. future.
This is an opportunity for the trading community to move large stockpiles for the last gasp of tax loss harvesting or to position for the new year. Trading volume will typically drop by 30%-40% in the last two weeks of the year after triple witching, with only the last trading day seeing significant volume.
All this may seem of only academic interest, but the big move toward passive index investing over the past two decades has made these events more important to investors.
When these indexes are adjusted, either because of additions or deletions, because the number of stocks changes, or because the weightings are changed to reduce the influence of the largest companies, it means that there is a lot of money moving in and out of mutual funds and ETFs. are directly or indirectly linked to the indices.
Standard & Poor's estimates that nearly $13 trillion is directly or indirectly indexed to the S&P 500. The three largest ETFs (SPDR S&P 500 ETF Trust, iShares Core S&P 500 ETFAnd Vanguard S&P 500 ETF) are all directly indexed to the S&P 500 and collectively have nearly $1.2 trillion in assets under management.
Linked to the Nasdaq-100 – the 100 largest non-financial companies listed on the Nasdaq – Invesco QQQ Trust (QQQ) is the fifth largest ETF, with approximately $220 billion in assets under management.
S&P 500: Apple and others will be on sale. Uber goes in
For the S&P 500, Standard & Poor's will adjust the weighting of each stock to account for changes in the number of shares. The number of shares usually changes because many companies have large buyback programs that reduce the number of shares.
This quarter, Apple, Alphabet, Comcast, ExxonMobil, Visa And Marathon Petroleum will all see their share decline, so funds indexed to the S&P will have to reduce their weighting.
S&P 500: Companies with a reduction in the number of shares
(% of reduction in number of shares)
- Apple 0.5%
- Alphabet 1.3%
- Comcast 2.4%
- Exxon Mobil 1.0%
- Visa 0.8%
- Marathon Petroleum 2.6%
Source: S&P Global
Other companies (Nasdaq, EQTincluding Amazon) will see their share counts increase, so funds indexed to the S&P 500 will need to increase their weighting.
In addition, three companies are added to the S&P 500: Uber, JabilAnd Builders FirstSource. I wrote last week about the effect the addition to the S&P had on Uber's stock price.
Three other companies will be removed and move from the S&P 500 to the S&P SmallCap 600 index: Trapped air, Alaska air And SolarEdge Technologies.
Nasdaq-100 changes: DoorDash, MongoDB and Splunk are in
The Nasdaq-100 is rebalanced four times a year; however, the annual reconstruction, which involves adding or removing supplies, does not occur until December.
Last Friday, Nasdaq announced that six companies would be added to the Nasdaq-100: CDW company (CDW), Coca-Cola Europacific Partners (CCEP), DoorDash (DASH), MongoDB (MDB), Roper Technologies (ROP), and Splunk (SPLK).
Six others are removed: Align technology (ALGN), eBay (EBAY), Enphase energy (ENPH), JD.com (J.D.), Clear group (LCID), and Zoom video communication (ZM).
Concentration risk: the rules
Under federal law, a diversified investment fund (mutual funds, exchange-traded funds), even if it merely mimics an index like the S&P 500, must meet certain diversification requirements. This includes requirements that: 1) no single issuer can represent more than 25% of the total assets of the portfolio, and 2) securities representing more than 5% of the total assets must not represent more than 50% of the total portfolio .
Most major indexes have similar requirements in their rules.
For example, there are eleven S&P sector indexes that form the underlying indexes for widely traded ETFs, such as the Technology Select SPDR ETF (XLK). The rules for these sector indexes are similar to the rules discussed above regarding mutual fund diversification requirements. For example, the S&P sector indexes say that a single stock cannot exceed 24% of that sector index's float-adjusted market capitalization and that the sum of companies weighing greater than 4.8% cannot exceed 50% of the total index weight.
At the end of last week, three companies had a weight of more than 4.8% in the Technology Select Sector (Microsoft at 23.5%, Apple at 22.8% and Broadcom at 4.9%) and their combined market weight was 51.2 %, so if the prices remain the same at the close on Friday, there should be a small decline in Apple and Microsoft in that index.
S&P will announce on Friday after the close whether there are any changes in the sector indexes.
The Nasdaq-100 also uses a “custom” market capitalization weighting scheme, which can limit the size of the weighting for a given stock to address over-concentration risk. This rebalancing could reduce the weighting in some of the largest stocks, including Apple, Microsoft, Amazon, Nvidia and Alphabet.
The rise in these big tech stocks was so rapid in the first half of the year that Nasdaq took the unusual step of initiating a special rebalancing of the Nasdaq-100 in July to address the overconcentration of the biggest names. As a result, Microsoft, Apple, Nvidia, Amazon and Tesla all saw their weightings reduced.
Market concentration is nothing new
Whether the rules on market concentration should be tightened is up for debate, but the issue has been going on for decades.
For example, Nasdaq's Phil Mackintosh and Robert Jankiewicz recently noted that the weight of the five largest companies in the S&P 500 was also around 25% in the 1970s.
Disclosure: Comcast is the parent company of NBCUniversal and CNBC.