Nasdaq Rebalancing

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It must be a sign of the times: the recent outperformance of a handful of the largest tech companies has led to such a top-heavy imbalance in the Nasdaq 100 Index that it no longer complies with SEC regulations on diversification, and the Index’s managers will soon have to conduct a special rebalance to even things out. Nasdaq has only had to conduct this circuit-breaker of a procedure twice before, in 1998 and 2011, but now just six companies—Microsoft, Apple, Nvidia,, Tesla and Alphabet (Google)—account for over half of the benchmark, having rallied anywhere from forty to over two hundred percent in the first half of the year alone. Diversification is one of the most important attributes of an index, and if the regular methods of maintaining it have failed, something unusual must be happening.

What is behind this historic performance? First, it must be acknowledged that these are giant, transformative, and (with an arguable exception or two) highly profitable companies. Second, all of these companies saw very significant drawdowns in their share prices last year. In fact, most have not made new all-time highs this year, and some are still aways away. Third, the macroeconomic picture has improved over the last six-plus months, with inflation decelerating as steadily as it had been rising, and growth remaining resilient.

But shouldn’t a rising (or at least, no longer ebbing) tide lift more boats? According to Bank of America research, fewer than a quarter of the S&P 500 outperformed the Index in May, the lowest monthly reading in at least forty years, so the improvement in economic conditions seems to disproportionately benefit a select few. And while the risk of inflation has broadly improved, fundamentals for this basket of stocks have not. Among the six stocks previously mentioned, only Nvidia and, to a much lesser extent Alphabet, have had their earnings estimates for 2023 revised higher by Wall Street analysts. Amazon’s earnings are now projected to be ten percent lower than they were at the start of the year; Tesla fifteen percent lower; and Apple and Microsoft’s estimates are roughly flat. With earnings a mixed bag, the explanation for these higher prices is higher valuations—essentially, optimism. The future will show whether earnings at these companies will justify these imbalanced valuations.

As always, should you have questions related to this commentary, please contact us. From all of us at SouthState Wealth, we sincerely appreciate your business and friendship.

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