NASDAQ REBALANCE: WHAT YOU NEED TO KNOW

This article was originally published on Forbes on Jul 28, 2023,12:07am EDT

On June 30th, the NASDAQ posted the strongest first six months in the index’s history, dating back to 1971. The 6-month returns of 30.5% in 2023 easily beats the prior record of 25.2% in 2019. The majority of the rally was driven by seven stocks: Apple, Microsoft, Nvidia, Amazon, Tesla, Meta, Google. These 7 stocks are up a collective 98% YTD, while the equal weight S&P 500, which provides an equal weighting to all 500 stocks in the index, is up only 9%.

Source: I/O Fund

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This level of narrow leadership continues to pose a problem for active managers who are more diversified than the NASDAQ-100. In fact, by Q1 of 2023, only 1/3 of active managers were ahead of their benchmark in 2023.

As a result, the NASDAQ is being forced by the SEC to rebalance their tech-heavy index, the NASDAQ-100, which will shift the focus away from the top seven stocks in the market, and redistribute weightings to less popular names in the index, like Starbucks and Broadcom, to name a few.

The reason for the rebalance is due to the Magnificent Seven taking up 55% of the Index’s weighting prior to the rebalance. Here was the NASDAQ-100’s weighting prior to the rebalance (as of July 18)

MSFT – 12.7%

AAPL – 12.1%

NVDA – 7.4

GOOGL – 7.3%

AMZN – 6.8%

TSLA – 4.5%

META – 4.4%

On July 14th, the new weighting was announced: NVDA and MSFT would receive the biggest cuts of about 3% each, while AAPL only got shaved by 1% (making it the new top position). Google was cut by 2%, while META and TSLA by 1%. The new rebalance dropped the overall weighting from 55% to ~38%. The NASDAQ-100 topped about 4 days later, and has since been in a minor correction.

Being a static index, a rebalance is a rare occurrence, as it has only happened twice since 1998. The last time was in April of 2011 and was focused on Apple’s outsized weighting in the index. At the time it accounted for just over 20%, and was rebalanced back to 12%. Below shows when this was announced and how it affected the stock. Though the macro environment was much different in 2011, it’s worth noting that Apple had an immediate dip that was quickly bought.

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Source: I/O Fund

We believe this is worth monitoring as $209 Billion is currently in QQQ, an ETF that tracks the NASDAQ-100. This means that MSFT, for example, lost $18.8 Billion in demand from this single ETF having to rebalance in accordance with the new changes. Furthermore, many institutional funds are benchmarked to this index, and are in the process of rebalancing their portfolios to coincide with these changes, which should further affect demand.

Our current take on the market is that if SPX break below 4515, then the market has likely topped. Below 4275 and SPX has put in a big top and this would be bearish. On the other hand, if 4275 is defended, then our firm will layer into more stocks as this would be bullish. The level of 4275 is of critical importance and we will update our Premium Members with our buy plan if we get here.

Source: I/O Fund

I/O Fund Portfolio Manager, Knox Ridley, contributed to this article .

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