Friday’s S&P 500 and Nasdaq-100 rebalance may reflect concerns over concentration risk

It’s arguably the biggest stock story of 2023: a small number of giant technology companies now make up a very large part of big 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 about 40% of the Nasdaq-100. 

The S&P 500 and the Nasdaq are rebalancing their respective indexes this Friday. While this is a routine event, some of the changes may reflect the concerns over concentration risk. 

A ton of money is pegged to a few indexes 

Now that the CPI and the Fed meeting are out of the way, these rebalances are the last major “liquidity events” of the year, corresponding with another notable trading event: triple witching, or the quarterly expiration of stock options, index options and index futures. 

This is an opportunity for the trading community to move large blocks of stock for the last gasps of tax loss harvesting or to position for the new year. Trading volume will typically drop 30%-40% in the final two weeks of the year after triple witching, with only the final trading day showing significant volume.

All of this might appear of only academic interest, but the big move to passive index investing in the past 20 years has made these events more important to investors. 

When these indexes are adjusted, either because of additions or deletions, or because share counts change, or because the weightings are changed to reduce the influence of the largest companies, it means a lot of money moves in and out of mutual funds and ETFs that are directly or indirectly tied to the indexes. 

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 ETF, and 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 nonfinancial companies listed on Nasdaq — the Invesco QQQ Trust (QQQ) is the fifth-largest ETF, with roughly $220 billion in assets under management. 

S&P 500: Apple and others will be for sale. Uber going in 

For the S&P 500, Standard & Poor’s will adjust the weighting of each stock to account for changes in share count. Share counts typically change because many companies have large buyback programs that reduce share count. 

This quarter, Apple, Alphabet, Comcast, Exxon Mobil, Visa and Marathon Petroleum will all see their share counts reduced, so funds indexed to the S&P will have to reduce their weighting. 

S&P 500: Companies with share count reduction

(% of share count reduction)

  • 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, EQT, and Amazon among them) will see their share counts increased, so funds indexed to the S&P 500 will have to increase their weighting. 

In addition, three companies are being added to the S&P 500: Uber, Jabil, and Builders FirstSource.  I wrote about the effect that being added to the S&P was having on Uber‘s stock price last week.  

Three other companies are being deleted and will go from the S&P 500 to the S&P SmallCap 600 index: Sealed Air, Alaska Air and SolarEdge Technologies

Nasdaq-100 changes: DoorDash, MongoDB, Splunk are in 

The Nasdaq-100 is rebalanced four times a year; however, the annual reconstitution, where stocks are added or deleted, happens only in December. 

Last Friday, Nasdaq announced that six companies would be added to the Nasdaq-100: CDW Corporation (CDW), Coca-Cola Europacific Partners (CCEP), DoorDash (DASH), MongoDB (MDB), Roper Technologies (ROP), and Splunk (SPLK). 

Six others will be deleted: Align Technology (ALGN), eBay (EBAY), Enphase Energy (ENPH), JD.com (JD), Lucid Group (LCID), and Zoom Video Communications (ZM).

Concentration risk: The rules

Under federal law, a diversified investment fund (mutual funds, exchange-traded funds), even if it just mimics an index like the S&P 500, has to satisfy certain diversification requirements. This includes requirements that: 1) no single issuer can account for more than 25% of the total assets of the portfolio, and 2) securities that represent more than 5% of the total assets cannot exceed 50% of the total portfolio. 

Most of the major indexes have similar requirements in their rules. 

For example, there are 11 S&P sector indexes that are 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 on diversification requirements for investment funds discussed above. For example, the S&P sector indexes say that a single stock cannot exceed 24% of the float-adjusted market capitalization of that sector index and that the sum of the companies with weights greater than 4.8% cannot exceed 50% of the total index weight. 

At the end of last week, three companies had weights greater 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 those same prices hold at the close on Friday, there should be a small reduction in Apple and Microsoft in that index. 

S&P will announce if there are changes in the sector indexes after the close on Friday. 

The Nasdaq-100 also uses a “modified” market-capitalization weighting scheme, which can constrain the size of the weighting for any given stock to address overconcentration risk. This rebalancing may reduce the weighting in some of the largest stocks, including Apple, Microsoft, Amazon, Nvidia and Alphabet. 

The move up in these large tech stocks was so rapid in the first half of the year that Nasdaq took the unusual step of initiating a special rebalance in 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 around market concentration should be tightened is open for debate, but the issue has been around for decades.

For example, Phil Mackintosh and Robert Jankiewicz from Nasdaq recently noted that the weight of the five largest companies in the S&P 500 was also around 25% back in the 1970s.

Disclosure: Comcast is the corporate parent of NBCUniversal and CNBC.

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Top Wall Street analysts favor these stocks for the long haul

Sanjay Mehrotra, CEO, Micron

Scott Mlyn | CNBC

The S&P 500 and Nasdaq notched a solid performance in the first half of 2023, thanks to an impressive rally in major tech stocks. However, macro pressures have not abated, with minutes from the latest Federal Open Market Committee meeting hinting at more interest rate hikes to tame high inflation.

Given the ongoing uncertainty, investors could benefit by looking at stocks with strong fundamentals and long-term growth potential.

Here are five stocks chosen by Wall Street’s top analysts, according to TipRanks, a platform that ranks analysts based on their past performance.

Micron

First up is chipmaker Micron (MU), which reported better-than-feared fiscal third-quarter results in late June. The company cautioned that the recently imposed ban on its products by China remains a major headwind. However, investors chose to focus on management’s commentary on improving business conditions, with artificial intelligence driving strong demand for Micron’s memory chips.

Goldman Sachs analyst Toshiya Hari expects Micron’s near-term financial performance to continue to be noisy due to several factors, including the revenue uncertainty associated with the Cyberspace Administration of China’s ban and inventory-related issues.

Nevertheless, the analyst maintained a buy rating on Micron with a price target of $80, saying, “We have confidence in the company’s ability to mitigate potential share loss in China and drive share gains in the HBM3 market over time, while executing on its DRAM and NAND technology roadmaps.”

Hari believes that the company’s solid position in the DDR5 market, which is the latest generation of high-performance memory chips, and the prospects for its high bandwidth memory HBM3 chips (mass production to begin in early 2024) position it well to take advantage of the rapid growth in the AI space.

Hari’s recommendations are worth considering, as he is ranked No. 155 among more than 8,400 analysts tracked on TipRanks. His ratings have been profitable 64% of the time, with each rating delivering an average return of 19.7%. (See Micron Stock Chart on TipRanks)

Texas Roadhouse

Restaurant chain Texas Roadhouse (TXRH) is facing elevated input costs due to sky-high inflation. Despite near- and medium-term margin pressures, Wedbush analyst Nick Setyan continues to believe in the company’s ability to gain further market share in the casual dining restaurant space.

Checks by the analyst’s firm indicate that TXRH is set to deliver second-quarter same-store sales growth ahead of the consensus estimate of 8.2%. Accordingly, Setyan raised his Q2 same-store sales growth estimate from 8.5% to 9.5% to reflect robust dine-in traffic, the impact of increased local marketing efforts, and a higher off-premise mix.

Setyan expects continued strength in the company’s sales to more than offset the ongoing food cost inflation, including beef. He slightly increased his 2023 and 2024 EPS estimates, given his expectation of top-line upside.     

In line with his investment thesis, Setyan reaffirmed a buy rating on the stock with a price target of $123. He explained that his price target reflects a premium valuation, which is “appropriate given our expectation of accelerating market share gains within casual dining for the foreseeable future.”

Setyan holds the 798th position among more than 8,400 analysts on TipRanks. Additionally, 51% of his ratings have been profitable, with an average return of 7.2%. (See TXRH Blogger Opinions & Sentiment on TipRanks)

Carnival

Next on this week’s list is cruise operator Carnival (CCL). After being battered by pandemic-led lockdowns, Carnival and several other travel stocks have bounced back strongly this year due to robust travel demand.

Tigress Financial analyst Ivan Feinseth expects Carnival to benefit from solid bookings, higher pricing, and the reprioritization in consumer spending on travel. He projects revenue, economic operating cash flow, and net operating profit after tax to exceed pre-pandemic record levels by mid-2023.

“CCL’s accelerating Business Performance trends and significant recovery in cash flow continue to enable the ongoing funding of key growth initiatives, fleet expansion/transition, upgrades, and debt reduction,” said Feinseth, who ranks 174 out of more than 8,400 analysts tracked on TipRanks.  

The analyst noted that Carnival paid down $1.4 billion of its debt in the fiscal second quarter. CCL is expected to reduce its debt levels to less than $33 billion by the end of 2023, supported by improved cash flows. The company’s debt peaked at over $35 billion due to the disastrous impact of the pandemic on cruise lines.    

Feinseth reaffirmed a buy rating on CCL and boosted his price target to $23 from $13. He has a success rate of 62% and each of his ratings has returned 13.1%, on average. (See CCL Insider Trading Activity on TipRanks)

MongoDB

Feinseth is also bullish on database software maker MongoDB (MDB), which delivered market-beating results for the fiscal first quarter ended April 30 and raised its full-year guidance. The company had more than 43,100 customers at the end of the period, after witnessing the highest net new customer additions in more than two years.

Feinseth expects the growing integration of generative AI tools and capabilities will drive increased adoption of MongoDB’s highly customizable and scalable database as a service platform by enterprise customers.

The analyst said the company will continue to use its solid cash flows to invest in growth initiatives, including innovation, strategic acquisitions, marketing efforts to attract more customers, and international expansion.

“MDB will continue to benefit from increasing enterprise IT spending driven by enterprises’ ongoing needs to leverage AI capabilities as a growing competitive advantage,” said Feinseth.

Even after the solid year-to-date rally in MDB shares, Feinseth sees further upside in the stock. Accordingly, he reiterated a buy rating and increased the price target to $490 from $365. (See MongoDB Financial Statements on TipRanks)   

Amazon

E-commerce giant Amazon (AMZN) is holding its much-awaited 9th annual Prime Day on July 11 and 12. Prime Day is an annual sales event exclusively held for Amazon Prime members, which helps the company deepen its relationship with existing members and win new ones. 

JPMorgan analyst Doug Anmuth expects the 2023 Prime Day to see elevated demand despite a tough macro backdrop. The analyst projects Prime Day will generate about $7 billion in revenue, up more than 12% year-over-over, with gross merchandise value expected to increase more than 13% to $11 billion.

Anmuth highlighted the initiatives taken by Amazon over the past two years to strengthen its network. In particular, the company doubled the size of its retail network, established a massive last-mile transport network, and implemented a new sortation network to increase the speed of delivery for long-distance orders.

Amazon has also transitioned from a national U.S. fulfillment network to a regional model comprising eight interconnected regions to optimize inventory placement and other processes, reduce delivery costs, and boost speed.

“As such, Amazon should be well-equipped for the elevated demand of Prime Day, & the event should also help AMZN right-size inventory ahead of heavier demand deeper into 2H around the holidays,” explained Anmuth.

Amazon continues to be Anmuth’s “best idea,” with a buy rating and a price target of $145. Anmuth is ranked No. 110 among more than 8,400 analysts tracked by TipRanks. His ratings have been profitable 61% of the time, with each rating delivering an average return of 16.7%. (See Amazon Hedge Fund Trading Activity on TipRanks)          

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