NASDAQ Composite Index experienced its first-ever "special adjustment," what happened?

On July 24th, the Nasdaq 100 Index (referred to as "Nasdaq 100") will undergo its first-ever special rebalance to address the issue of index concentration by redistributing weights.

The unprecedented rule modification by Nasdaq is closely related to the continuous rise of tech giants. Can the regulatory authorities tolerate the surge in tech stocks this year?

On July 11th, Cameron Lilja, Vice President and Global Head of Index Products and Operations at Nasdaq, stated in an interview with Bloomberg that this adjustment is purely aimed at reducing index concentration from a regulatory perspective.

Lilja explained that this rebalance is intended to help fund managers who are linked to or benchmarked against the Nasdaq 100 Index comply with the diversification rules of the U.S. Securities and Exchange Commission (SEC):

This rule requires the total weight of the largest holdings (with a proportion above 5%) to be limited to within 50%.

The Nasdaq 100 Index includes the 100 largest companies traded on the Nasdaq Stock Exchange. The changes in index weights may cause investment funds tracking this index to adjust their portfolios and sell stocks of companies whose weights have been reduced in the index.

According to the rebalance rules, if the combined weight of the top few companies (with a weight of 4.5% or above in the index) exceeds 48%, Nasdaq will adjust the weights of the index until their total weight in the index does not exceed 40%.

Since the beginning of this year, the Nasdaq 100 has risen by 39%, and this increase is mainly driven by the seven heavyweight stocks: Microsoft, Apple, Alphabet, NVIDIA, Amazon, Meta, and Tesla.

As of July 7th, these seven companies accounted for 55% of the weight in the Nasdaq 100. Among them, Microsoft has the highest weight at 12.9%, followed by Apple (12.5%), Alphabet (7.4%), NVIDIA (7%), Amazon (6.9%), Tesla (4.5%), and Meta (4.3%).

Strategas Securities' Managing Director of ETF and Technology Strategy, Todd Sohn, expressed his views on the Nasdaq 100 index rebalancing:

"In my opinion, this is a good thing as it reduces the concentration risk for market participants. On the other hand, it increases the weight of the remaining components of the index - what I like to call the 'benchwarmers' - which will continue to improve and strengthen the index."

Can the tech giants still rise?

Influenced by the news of the Nasdaq 100 index rebalancing, US tech giants generally experienced a decline on Monday. However, on Tuesday, the tech "Big Seven" showed mixed performance, with Meta, Amazon, Microsoft, Alphabet, and Tesla all rising.

Alon Rosin, Head of Equity Derivatives at Oppenheimer & Co., stated that the tech heavyweights performed poorly after the rebalancing announcement. They all experienced some degree of impact, and there were changes in fund flows after the announcement.

Chris Harvey, an analyst at Wells Fargo Securities, wrote in a report that companies like Starbucks, Mondelez, and Booking will benefit from the rebalancing adjustment.

Harvey believes that although heavyweight index-tracking ETFs like Invesco QQQ Trust will also need to adjust their holdings proportionally after the rebalancing, the rebalancing strategy itself is unlikely to have a profound impact on the future performance of the Nasdaq 100 index. Tech giants such as Apple, Microsoft, and Amazon will still dominate the index.

Sohn from Strategas pointed out that in an ideal scenario, the stocks in the latter part of the QQQ holdings may see an increase in their influence:

But I don't think it will have any significant impact after a day or two.