The Nasdaq 100 Index (NDX) is a modified market-cap index, comprising the largest 100 non-financial Nasdaq stocks. The market-cap valuation remains one of the primary factors in its overall methodology. The index rebalances every quarter to maintain the five biggest market-cap weighted names below the 40% threshold.
The rapid rise in the seven (7) largest components of NDX has forced Nasdaq to announce a special rebalance on 7/14/23 to address the over-concentration in the index by redistributing the weights. The Nasdaq has conducted two special rebalances in its history, during December 1998 and May 2011.
Although no new stocks in the index will be added or removed, the adjustment next week will likely impact seven components, including MSFT (12.9% mkt-cap), AAPL (12.5%), NVDA (7%), AMZN (6.9%), TSLA (4.5%), META (4.3%), GOOGL (3.7%), and GOOG (3.7%), which collectively account for more than 50% of its overall weighting of the index.
The announcement last Friday and the overbought conditions may be one of the reasons why the mega-cap technology names have corrected. While the correction continues?
According to the Nasdaq 100 methodology, the five (5) largest names in the index (AAPL, MSFT, GOOGL, AMZN, and NVDA) currently account for around 46.7% of the market-cap weighting. The new combined weighting will be capped at a maximum weighting of 38.5%.
The special rebalancing expected on Friday after the close will show the new weightings. It may impact QQQ and other NDX-related passive mutual funds and ETFs, as the rebalancing will result in investors shifting their stock allocation to track the underlining index.
However, the impacts may be minor and temporary. Since it is an adjustment rather than an addition or deletion, it may not impact the overall stock market or the NDX index. Also, many passive index funds and ETFs are S&P 500 Index based, and there are signs of a new SPX rebalancing.
A few mega-cap technology names may have influenced the internal health of the overall stock market. A special rebalance will help to rebalance the overall weighting of NDX and reset investors' expectations after the explosive returns in the mega-cap stocks this year.
For instance, NDX has returned over 37% for the year, NVDA has tripled, META jumped 140%, and TSLA gained 123%. QQQ has also appreciated 37% in 2023, while the equal weight QQQ ETF (QQEW) has gained only 18.0%. The discrepancy highlights the heavy influence of the mega-cap technology stocks on the market-cap-weighted ETF.
The special rebalancing may still influence the mega-cap names, at least from a near-term perspective, resulting in possible short-term gains or losses in the seven NDX stocks.
Technically speaking, there are also visible divergences developing between NDX and XLK. The Technology Select Sector ETF peaked at 175.93 (6/16/23), marginally surpassing its all-time high of 174.57 (12/28/21). Although NDX has rallied strongly to 15,284.65 (6/16/23), exceeding 15,265.42 (3/29/22 previous reaction high), it is still trading significantly below its all-time high of 16,764.86 (11/22/21).
The explosive 43.23% NDX rally from the 12/28/22 low (10,671.19) to the recent 6/16/23 high (15,284.65) warns of an overbought condition. However, it still retains its uptrend channel between 13,812 and 15,496. Nonetheless, failure to clear the top of the uptrend channel coupled with a lower low pattern (15,284.65 – 6/16/23 and 15,275.18 – 7/5/23) warns of near-term consolidation. Above 15,275.18-15,284.65 reaffirms a breakout and the resumption of the uptrend. A breakdown below 14,687.02 (6/26/23 low and Mar 2023 uptrend) confirms a 1-month h/s top and the start of a correction toward 14,089-14,262 (h/s top breakdown target and the 50-day ma) and below this 13,656 -13,812 (5/25/23 gap-up, May 2023 breakout, and the Jan 2023 uptrend).
Failure of XLK to follow through with its breakout to record highs may signal a double top and the start of a deeper correction. On the other hand, new all-time highs reaffirm a pivotal breakout and the next outperformance cycle.
In summary, the technology sector and the seven (7) mega-cap technology names have driven the 2023 rally. Negative divergences between XLK and NDX may signal a peak in the rally reaffirming the market correction. However, confirmations of higher highs from XLK and NDX reinforce the technology leadership roles in the bull rally.
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