Nasdaq 100 Index’s Special Rebalancing and Its Impact

The recent “special rebalancing” of the Nasdaq 100 Index, which came into effect on July 24, has been a topic of discussion. However, it is unlikely to have any substantial effect on the overall performance of the index or the individual stocks involved.

The motivation behind this rebalancing was to address the issue of “overconcentration” caused by the significant growth of six high-tech stocks. These stocks, namely Microsoft, Apple, Alphabet, Nvidia, Amazon.com, and Tesla, had collectively come to represent over 50% of the index’s combined market capitalization. As a result, the rebalancing was implemented to reduce their collective weight to 40%.

Initially, many expected a negative impact on these six stocks because a significant amount is invested in index funds benchmarked to the Nasdaq 100. However, when we look at past instances of similar special rebalancing, history tells a different story. Let’s consider two previous instances.

In December 1998, the Nasdaq 100 underwent a special rebalancing due to Microsoft’s dominant position, representing over 25% of the index’s market cap. As a result of the rebalance, Microsoft’s index weight decreased significantly. Contrary to concerns at that time, Microsoft stock actually gained over 70% in the following 12 months.

A similar pattern emerged with Apple after the special rebalance in 2011. Despite Apple’s index weight being reduced from over 20% to 12%, its shares rose by more than 70% in the subsequent year.

Additionally, as depicted in the above chart, both the 1998 and 2011 rebalances had no notable impact on the overall performance of the Nasdaq 100 Index itself. Its returns in the 12 months following these rebalancings were not significantly different from the preceding 12-month period.

Therefore, based on historical evidence, it appears that the recent “special rebalancing” is unlikely to have a profound effect on the Nasdaq 100 Index or the individual stocks involved. While there may be speculation and concern, past instances suggest that the impact could be minimal, if any.

Theories and Realities

It’s difficult to draw confident conclusions from just two rebalancings, and it certainly seems plausible that an index that becomes too concentrated will be riskier. But such concerns are largely theoretical at this point rather than immediate causes for concern.

Lack of Evidence for Market Concentration

That’s because there’s little evidence that the stock market is systematically becoming more concentrated. You may find that surprising, given myriad headlines bemoaning increasing overconcentration. In fact, the long-term trend has remained steady.

Chart Analysis

This is illustrated by the chart above, which plots for each year since 1980 the number of stocks in the S&P 500 required to constitute 50% of the index’s combined market cap. The year-end-2002 level is not significantly different than the four-decade average.

Performance of Equal-Weight Version

Another indication that concerns about overconcentration are overblown is the performance of the equal-weight version of the S&P 500. If the cap-weighted version of the index were becoming top-heavy, you’d expect to see a significant deviation between its performance and that of the equal-weight version. Such a gap hasn’t emerged, however.

In nine of the past 19 calendar years in which the Invesco S&P 500 Equal Weight ETF has existed, the cap-weighted version has come out ahead. It has lagged 11 times. Overall, the two have performed remarkably similarly.

The Bottom Line

When assessing the outlook for the overall market or individual tech stocks, there are far more significant factors to take into account than the Nasdaq 100’s special rebalance.

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