Morning Briefing | What You Need to Know About the Nasdaq 100 Rebalancing
Johnson & Johnson raises full-year outlook on rebound in demand. Johnson & Johnson (JNJ) reported second-quarter earnings on Thursday, and revenue and adjusted earnings beat Wall Street's estimates. Sales in the company's MedTech division, which offers surgical, orthopedic, and vision devices, surged as demand for nonurgent surgeries among older adults picked back up. This group had postponed such procedures during the pandemic. As a result of the strong performance, Johnson & Johnson raised its full-year guidance.
Analysts raise year-end market expectations, but 20% drop still possible . So far, the S&P 500 has surpassed most of Wall Street's year-end predictions. It has defied concerns over recession risks, inflation, and monetary tightening. The unexpected rally has put strategists in a dilemma, as they face pressure to revise their forecasts higher. Piper Sandler's Michael Kantrowitz, previously the most bearish strategist, raised his year-end target level for the index from 3,225 to a range of 3,600 to 3,800. However, the lower end of that range means we could still see a potential 20% decline over the next five months – which constitutes a bear market.
Nasdaq rebalance and options event leads to market frenzy. The Nasdaq 100 will see an out-of-cycle rebalancing, aimed at reducing the influence of Big Tech stocks and boosting the weight of smaller stocks. JPMorgan Chase analyst Min Moon estimates there will be $60 billion in two-way transactions. The changes are set to take place on Monday and coincide with a flood of expiring options today. Passive investors are using this window to align their portfolios with the benchmark before the changes take effect, leading to potential short-term volatility.
Bernanke says next rate hike may be last. Former Federal Reserve Chair Ben Bernanke believes the central bank will likely raise rates again at its next meeting. However, he said that rate hike may also be the last in the current tightening campaign. Investors seem to share this sentiment. According to the federal-funds futures market, they are pricing in a near-certain rate hike at the Fed's July meeting, with limited chances of further increases thereafter.
Japanese inflation picks up in June. Japan's consumer prices showed a faster-than-expected increase in June, indicating persistent inflationary pressures ahead of the Bank of Japan's meeting next week. Prices excluding those for fresh food rose 3.3% year over year, slightly accelerating from May as energy prices held less of an impact on inflation. However, a broader measure of inflation that excludes energy decelerated to 4.2% after reaching a 40-year high the previous month.
U.K. rents reach new high. Average rent for new tenants in London hit a new record in the second quarter, driven by high demand and increased mortgage rates. Tenants in London are facing an average monthly rent of £2,567 ($3,310), representing a 13.7% increase from a year ago. Compared with pre-pandemic levels, rents are up 28%. The surge in rental costs is weighing on U.K. consumer confidence, which fell for the first time in six months. Even more, it raises concerns about the impact of soaring prices on household finances.
BOE watchers say likelihood of 7% interest rates is falling. Two Bank of England ("BOE") forecasters who previously warned that U.K. interest rates may reach 7% have now said the risk has decreased after a significant drop in headline inflation. JPMorgan Chase economist Allan Monks believes the risk has declined, but warns that inflation could still remain above 2%. Adam Posen, president of the Peterson Institute for International Economics and a former member of the BOE's rate-setting committee, agrees that the likelihood of rates reaching 7% has decreased, though he advises against ruling it out completely at this stage.
Talk of a fresh interest-rate hike has been dominating the headlines as the next Federal Reserve meeting looms ahead. But also on the docket for next week is another key economic event happening for some of the biggest names in the market...
For the third time in its entire history, the Nasdaq 100 Index will undergo a special rebalancing.
Sure, the index gets minor rebalances every quarter. But next week's rebalancing is particularly important.
It'll address a problem that has been plaguing the Nasdaq 100 as of late – one you can thank Big Tech for. And that's the issue of concentration.
This benchmark index tracks the performance of the largest non-financial companies listed on the Nasdaq stock exchange. And over the past year, a handful of tech (and tech-ish) companies have experienced significant growth.
This has led to a lack of diversity within the Nasdaq 100. At one point, just seven companies accounted for more than half of the index's total weight.
Along with the Nasdaq 100, those major players even fueled the larger Nasdaq Composite (which includes the Nasdaq 100 constituents plus thousands of other tech stocks). And both indexes have been outperforming the S&P 500. Take a look...
To address this concentration issue, the Nasdaq committee will use a modified market-cap-weighted methodology for the index. This ensures that no individual constituent can carry a weight greater than 24% of the index. And for constituents with weights greater than 4.5%, it'll also keep their total weight under 48%.
However, earlier this month, Tesla's (TSLA) surge pushed the collective weight of these high-weight constituents beyond the threshold, prompting the need for a rebalancing. Here's what Big Tech will look like after the rebalancing...
Among the most affected companies are Nvidia (NVDA) and Microsoft (MSFT), both of which will see their weights decrease by approximately 3 percentage points. The redistributed weight will be allocated to smaller caps within the index.
The rebalancing will take effect before the market opens on Monday, July 24, and it's expected to have implications for both passive and active mutual funds benchmarked to the Nasdaq 100 Index. According to analysts at EPFR Global, approximately $251 billion in assets under management from passive mutual funds and exchange-traded funds are tied to the index.
Rebalancing events, especially when executed by passive funds, can create some level of market churn. However, the details of the rebalancing have been known since Nasdaq's announcement on July 10. So the trading activity that has taken place since could lessen the chances of significant volatility.
In fact, during the previous week, the top seven Nasdaq 100 stocks outperformed the index, suggesting that traders and investors may have already factored in the rebalancing.
Also, when you look at previous special rebalances, it becomes clear that they tend to be uneventful in the long run.
For instance, a special rebalancing occurred in 2011 when Apple's (AAPL) weight in the index reached an uncomfortable 20%. Despite the reallocation of a significant portion of Apple's weight to Microsoft, there was no lasting effect on share prices. This precedent suggests that next week's rebalancing is unlikely to have a profound impact on the overall market.
While events like these may cause some short-term market churn, history suggests that the effects from rebalancing tend to be temporary. But it's still crucial for investors to stay informed on events like these and keep a closer eye on your portfolio..
The U.S. boasts a robust and diverse economy... one that still seems to be humming along today, no matter how hard the Federal Reserve tries.
Now, each state plays a unique role in the nation's overall growth and prosperity.
So for this week's "Check This Out" section, I'm sharing a graphic from Visual Capitalist that breaks down America's $20 trillion economy by state.
In the chart below, you'll see each state's real gross domestic product ("GDP"). You'll also see who the economic powerhouses are... and who's stepping onto the scene.
Check it out...
The three states that dominate the U.S. economy are California, New York, and Texas. (Florida isn't too far behind, but we'll focus on just these three today.)
California's economy is the largest in the U.S., with a staggering real GDP of $2.9 trillion. In fact, if California were a country, it would rank among the top 10 biggest GDPs worldwide. It would come in fifth overall, trailing behind economic giants like Germany and Japan. The state's economy is driven by many factors – from Hollywood and Silicon Valley... to the size of its population (it has the largest population in the U.S.). Even more, California is home to corporate powerhouses like Disney (DIS), Apple (AAPL), Alphabet (GOOGL), and Meta Platforms (META).
Texas comes in second, with real GDP of $1.9 trillion. The Lone Star State's economy is driven by many industries, including advanced manufacturing, biotechnology, life sciences, aerospace, and more. Notable companies like Tesla (TSLA) and Texas Instruments (TXN) have made the state a hotbed for job opportunities and innovation. It also has the second-largest workforce in the country (behind California), coming in at 14 million people. And if Texas were a country, its economy would be comparable to those of Russia and South Korea.
New York follows closely behind Texas, with real GDP of $1.6 trillion. It's known for the bustling metropolitan center of New York City, which happens to be one of the top tourist destinations in the world. NYC is also considered a job hub for those in communication, banking, and finance. (New York's finance industry, unsurprisingly, is synonymous with Wall Street. And the sector brings in the most GDP for the state, at $429 billion.) Overall, New York's economy is built on diverse industries like insurance, agribusiness, clean energy, and cybersecurity.
While established economic powerhouses continue to dominate, emerging cities and states are also making significant strides. North Carolina, for example, is recognized as the best state to do business in, thanks to the accessibility of capital and the vibrant tech and innovation culture.
It's inevitable that the U.S. economy will evolve. And the balance of economic power may shift. For now, though, California, New York, and Texas remain at the forefront, driving the nation's economic growth.
Remember, if you wish to be featured in next week's "mailbag" issue, you have until noon Eastern time today to shoot us an e-mail.
As always, all thoughts, questions, and commentary can be sent to new@stansberryresearch.com.
Until Monday,
Kevin Sanford, MBA
July 21, 2023
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