Those in charge of designing the most important Wall Street indices, such as S&P, Nasdaq or MSCI, have been facing a great dilemma in recent weeks. It is not strange for any market agent to see how the reference indices are beginning to have an excessive influence on the values of great weight.
The Nasdaq’s plan to reconfigure its component weights launched on Monday is giving investors pause about the broader concentration risks in US equity markets, especially in passive portfolios.
The reason for this decision was to avoid over concentration by balancing the weights of the values. Especially after seeing the strong movements that only 10 companies in the index have suffered, the big technologies are aiming for returns this year 2023 close to 50% and their capitalization is gaining ground: only Apple and Microsoft weigh 14.50% in the S&P index 500 and the first ten companies weigh just over 30%. The proposed rebalancing tries to avoid these concentration risks by limiting the aggregate weights of index members whose weights exceed 4.5% to 40%.
From Welzia Management they emphasize that this decision will have a direct effect on the markets, as well as ETFs and funds indexed to the Nasdaq 100. “For example, the Invesco ETF (QQQ) has 200,000 million dollars linked to the Nasda q 100 index, and the The most important effect may be a certain selling weight in positions like Apple or Microsoft; while companies in the consumer discretionary sector will have a greater weight as a result of the rebalancing”, they say. However, he believes that the impact “will be limited” on the affected companies and “temporary”.
As Luis Francisco Ruiz, an analyst at CMC Markets, indicates, according to the index calculation methodology, in the new weighting the 5 companies with the highest weighting do not need to have a weight greater than 38.5% in the index. These companies are currently Microsoft, Apple, Google, Amazon and Nvidia with a weight of more than 45% in the index. “This circumstance suggests that the weight in these companies will be adjusted…At the same time, outside of the five companies with the highest weight, no company will be able to exceed a 4.4% weighting in the index, which suggests that Tesla could also see its weight revised downwards”, highlights the expert.
The ball is in the court of the S&P 500
But concentration risks go beyond the Nasdaq. The S&P 500 is also heavily weighted toward the larger stocks, especially in the technology and e-commerce sectors. As of the end of June, the top 10 stocks accounted for 32% of the S&P 500, with a combined market capitalization of $12.2 trillion. This figure dwarfs the value of the main benchmarks in Germany, China, the UK and Japan.
Valuations of large-cap US companies have skyrocketed. “The median P/E ratio for the Big 10 soared 48%, up to 28.2 times, at the end of June, versus an average rise of just 7% for the rest of the market. Valuations of the Big 10 were boosted by multiple expansion, as median EPS estimates rose just 0.2%; for the rest of the market, the median EPS forecast fell 0.4%”, analyzes AllianceBernstein.
“This suggests that, in the market as a whole, investors can find securities with relatively attractive valuations for their profit potential,” according to the investment fund manager. In his view, active portfolios can look to a broader range of companies that suit today’s complex conditions. “Investors with a long horizon should resist the temptation to stack indiscriminately on the largest stocks and ensure that their portfolios offer multiple sources of growth potential, at the right price,” she explains.
On September 16, 2022, the last rebalancing of the S&P 500 already took place, but now new measures in this regard are not ruled out. Only this last adjustment in the North American selective boosted the flow of the estimated passive investment of 70,000 million dollars. We’ll see where the next moves go.
