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Lanon Wee

Friday's Rebalance of the S&P 500 and Nasdaq-100 Could Signal Worries About Concentration Risk

It is hard to overlook the biggest stock story of 2023: a handful of tech giants now comprise a major part of leading indices like the S&P 500 and the Nasdaq-100. Five companies (Apple, Microsoft, Amazon, Nvidia and Alphabet) count for close to 25% of the S&P 500 and six (Apple, Microsoft, Amazon, Nvidia, Alphabet and Broadcom) represent nearly 40% of the Nasdaq-100. This Friday will see a rebalance of these indexes. While routine in nature, this change may demonstrate concern regarding concentration risk. Significant money is tied to these indexes given the strong trend towards passive index investing witnessed in the last twenty years. This is the last major "liquidity event" of the year, with stock options, index options and index futures all due to expire, otherwise known as triple witching. This presents a chance to order large amounts of stock for tax losses or to ready for the new year, with trading often dropping 40% by the second week of the December. For the S&P 500, adjustments will be made to the weighting of respective stocks in order to account for changes in their share count. Companies likely to face reduced share counts include Apple, Alphabet, Comcast, Exxon Mobil, Visa and Marathon Petroleum, while those to experience an increase include Nasdaq, EQT and Amazon. Uber, Jabil and Builders FirstSource will be added to the S&P 500, while Sealed Air, Alaska Air and SolarEdge Technologies are switching to the S&P SmallCap 600. The Nasdaq-100's reconstitution will happen with the inclusion of CDW Corporation, Coca-Cola Europacific Partners, DoorDash, MongoDB, Roper Technologies and Splunk, with Align Technology, eBay, Enphase Energy, JD.com, Lucid Group and Zoom Video Communications being removed. With such close focus on concentrations of money in a few companies, it is not surprising that federal law dictates diversification in investment funds, like ETFs and mutual funds, that adhere to an index including a 25% cap on any single issuer and a maximum 50% limit for individual stocks holding more than 5% of the total assets of the portfolio. This is mirrored in the 11 S&P sector indexes where a single stock can't exceed 24% of the float-adjusted market capitalization and the sum of the top weighted companies can't exceed 50% of the index. The Nasdaq-100 also holds a "modified" market-capitalization weighting scheme that may lead to the decrease in the weighting of the largest companies. The overconcentration of the biggest names in technology this year has seen Nasdaq take an extraordinary step of initiating a special rebalance in the Nasdaq-100 in July, decreasing the weightings of Microsoft, Apple, Nvidia, Amazon and Tesla. While arguments remain for tightening regulations in this area, concentration of the market has been an issue for decades.

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