The Nasdaq 100 index will rebalance the weights of its component stocks this month, effective July 24. This move will reduce the weight of the largest companies, to counter the supremacy of heavyweight tech shares and avoid concentration. In isolation, this implies less demand for the largest stocks and more flows into smaller Nasdaq companies. Of course, several other factors will also influence these shares moving forward. 

“Special rebalancing”

A scorching rally has seen the Nasdaq 100 gain 42% so far this year, spearheaded by large tech stocks. The seven largest companies - Microsoft, Apple, Nvidia, Google, Amazon, Meta, and Tesla - now account for more than half of the entire index’s weight.

This concentration has led the Nasdaq exchange to announce a “special rebalancing”, in order to lessen the importance of these tech giants and shift more weight towards smaller companies. The new weights have not been announced yet, but it is almost certain that ‘big tech’ will lose some weight.

One exception might be Google. Because its parent company - Alphabet - is listed under two different tickers, that ‘technically’ splits its weight in half. Therefore, each individual Google ticker does not exceed 4.5% of the entire index, which is the Nasdaq’s threshold for weight rebalancing, even though they do when combined together.

What’s the market impact? 

There are two ways this rebalancing can impact trading dynamics. Firstly, after such a stunning melt-up in heavyweight tech shares this year, which has carried the entire Nasdaq higher, reducing their weight now would help shield the index from a selloff in case there is a correction lower in these names.

It would essentially mitigate some of the damage on the Nasdaq 100 if the biggest companies suffer a decline in the coming months, potentially helping to make the index more resilient.

Another major effect has to do with passive flows. Investment funds that track the Nasdaq 100 would need to recalibrate their exposure, selling shares of companies that would see their weight reduced and buying the stocks that will enjoy an increase in weight.

In other words, less demand for mega-cap shares and more demand for smaller companies, which will now represent a greater share of the index.

Now to be clear, these effects probably won’t be massive. The Nasdaq 100 is only one of many stock market indices, and the weight adjustments are unlikely to be dramatic.

Nonetheless, there will be some effect as portfolio managers adjust their exposure. We’ve already seen some glimpses of that this week, with Apple and Microsoft not really participating in the epic market rally after the US inflation data, most likely because traders are frontrunning this shift.

The big picture

Of course, there are several other forces that will shape the path for stock markets. Most notably, the earnings season will kick into top gear next week. Analyst estimates seem too pessimistic, setting the bar so low that corporate America will probably have an easy time jumping over it and delivering positive earnings surprises.

This might be the next source of fuel for equities. There is also the global macroeconomic environment to consider, the trajectory for interest rates, valuations, liquidity flows, and the hype surrounding artificial intelligence.

Looking at the Nasdaq 100 chart, the index is in a powerful uptrend. The next barrier for buyers to overcome will probably be the 15,700 zone, which served both as support and resistance in 2021.

However, momentum indicators point to overbought market conditions. If there is a correction lower, the 15,250 region could come into play.