Nvidia Soaring Stock Forces Tech ETF to Rebalance

Nvidia Soaring Stock Forces Tech ETF to Rebalance

As Nvidia (NVDA) stock continues its meteoric rise, it’s causing significant ripples in one of the largest technology-focused exchange-traded funds (ETFs), the $70 billion Technology Select Sector SPDR (ticker: XLK). This ETF, a heavyweight in the sector, faced a considerable shake-up. It was compelled to dramatically increase its holdings in Nvidia, one of the market’s most coveted stocks. Simultaneously, it reduced its investment in Apple (AAPL). Despite Nvidia shares declining by 3.22% recently, the fund’s rebalancing act was a direct response to regulatory requirements.

Navigating IRS Concentration Limits

The ETF’s restructuring is driven by the need to comply with IRS regulations. These rules dictate that individual stock positions exceeding 5% of a fund’s assets cannot collectively constitute more than 50% of the fund’s total holdings. Previously, XLK had about 22% of its assets allocated to each of Microsoft (MSFT) and Apple. These companies have market caps around $3.3 trillion. Nvidia, despite having a market value similar to its tech rivals, accounted for only 5.7% of the fund’s assets. This kept it comfortably within the IRS’s concentration limits.

However, the situation changed dramatically on June 14, during a critical index rebalancing. Nvidia’s market capitalization surged past that of Apple. Prompting XLK to boost its stake in Nvidia and cut back on Apple holdings. This adjustment was necessary. However, Nvidia’s stock fell later in the week, dropping behind Apple in market value once again.

Investor Implications and Market Dynamics

The benefits of this rebalancing to investors are contingent on the future performance of Nvidia and Apple stocks and the overall market concentration. Rob Anderson, U.S. sector strategist at Ned Davis Research, suggests that sticking with sector ETFs such as XLK could be advantageous. This is due to their convenience compared to managing individual stocks. Historical data supports this approach. Over the past 15 years, the tech ETF has yielded an average annual return of 19.9%. This is close to the 20.3% average return for tech stocks, as reported by Morningstar. This implies that, over time, the performance disparities between individual stocks and sector ETFs tend to level out.

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Market Trends and Highlights

This week, the S&P 500 (SPX) reached its 30th record close of the year. Nvidia experienced a 3.5% rise on Tuesday, just before the Juneteenth holiday. This surge allowed Nvidia to momentarily surpass both Apple and Microsoft in market capitalization. However, later in the week, its market cap slipped below those of Apple and Microsoft. Meanwhile, Treasuries nearly reached break-even for the year. In addition, the UK hit its 2% inflation target in May, which led the Bank of England to maintain steady interest rates. The Dow Jones Industrial Average climbed 1.45% for the week. Meanwhile, the S&P 500 edged up by 0.6%, and the Nasdaq Composite remained unchanged.

Corporate and Deal Updates

In corporate news, Apple announced the winding down of its buy-now, pay-later service introduced last year and reported a breakthrough by supplier TDK in solid-state battery technology. Adobe faced a lawsuit from the Federal Trade Commission for allegedly complicating the cancellation process of subscriptions. The electric vehicle startup Fisker filed for bankruptcy for the second time. Additionally, bank regulators identified weaknesses in the derivatives unwind plans of major banks. These banks include Citigroup, JPMorgan Chase, Bank of America, and Goldman Sachs. On a brighter note, Walt Disney’s “Inside Out 2” achieved blockbuster status. It grossed $155 million in the U.S. and $295 million globally during its debut.

In deal-making news, BlueTriton Brands, the parent company of Poland Spring water, agreed to merge with Primo Water in an all-stock deal. Shell announced its acquisition of liquefied natural gas trader Pavilion Energy from Singapore’s sovereign wealth fund Temasek. Honeywell confirmed its purchase of defense technology firm CAES Systems for $2 billion from private equity firm Advent International.

Looking Ahead

Next week promises significant updates as three major companies prepare to release their earnings: FedEx on Tuesday, Micron Technology on Wednesday, and Nike on Thursday. The Census Bureau will report new residential sales data for May. Economists are forecasting an annualized rate of 650,000 new single-family homes sold. Additionally, the Bureau of Economic Analysis will release the personal consumption expenditures (PCE) price index for May. Expectations indicate a 2.6% year-over-year increase, which is slightly down from April. The Institute for Supply Management will also release the Chicago Business Barometer for June, projected to show a modest recovery from recent lows.

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