Market Concentration and Future Outlook

Today's Animal Spirits, talkalk your book is brought to you by investco. Go to investcoot com to learn more about the NASAq one hundred ETF QQQ and their whole other innovation suite of ETFs. investco dot com learn more Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Rit Holz Weealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Rit Holzs Wealth Management may maintain positions in the securities discussed in this podcast Welcome to Animal Spirits with Michael and Ben. Michael, you always give me flack about my grand uppp' hedging capabilities I think it's a gift. you think it's a crutch sometimes. Someone asked us, I don't know, two years ago, what's the best way to invest in AI? And I said My Grand Rapids hedge is just own the NazAq one hundred. I think that's the easiest way you're going to get the winners, the winners rise to the top Listen to this stat. We talked about Micron a little bit and how it's now the third largest company in the QQQ ETF Pretty crazy. So it's over a five percent position. As of April twenty twenty six. and we're recording this on june twenty ninth twenty twenty in April of twenty twenty six, White Charts head the ability to look back at the holdings over different months and different time periods Micron was not in the top ten. of the Ques in April twow months ago Today, it's the third largest holding that happened really, really fast Right? And that's what I meant by the cream rises to the top The winners will sort themselves out It's not like this was a three year thing. This was a three month thing. Wow off going from outside the top ten to the third largest holding in the index. I'll do you one better or not to one up you. I will I will do you one equal, Ben Micron, year to date two hundred and ninety percent It is added alone. five point two percent for the year to day performance for the NSA one hundred. If you own the c is five point two percent of your year to day gain is from Micron Another two point eight percent is from AMD and this is in order twow point five percent of some intntel One, seven from Applied Materials and one, five each from LAamb Research and SandDisk And all right, let me do some F b N notot exactly the household names that you'd expect. But that's the AI trade. So the top, the top and then and then it's Lam Research and Sandis and KLA Corp and Marville and Cisco and Western Didge These are all AI, so Ben Take a bow, sir. You nailed it But we never we didn't talk about Google. Or meta or Microsoft or even NVIidia in there. That's pretty wild when you think about it. You know what? how the changes have tim's been We went we went thirty minutes. Talking about the cues And to your point, not once, I don't think Did we mention a Mag seven name Literally. No I no, no. I just said, How come micron is so much bigger than meta whichich is. You're right, Micron is now has twice the size in the index meta. prettyty crazy. We've talked Paul S shortter before Paul is the director of Factor and QQQ equity productuct strategy. And of course, we talked about the biggest topic everyone's been talking about in recent months, SpaceX IPO. when will it be included in the index? How does the NASAQ one hundred methodology work Michael, I feel like you've been very schooled on this This has been something that you've poured your heart and soul into. Which part index methodology Oh, well, we were getting questions Yes. So we go into the whole thing, how the NASDAQ one hundred works, how they make these decisions, how big of a position spaceXO B. All that and more, here is our conversation with Paul Schroder from InVestco P, welcome back. Hey, thanks for having, Michael. Good to be here. All right, we'll start with a question that I should know the answer to. In fact, I do' know the answer to this, but for the audience who doesn't for stocks to get into the NASA one hundred Do they need to be listed on the NASDAQ exxchange Correct. That's the only real hard and fast. requirement to be included within the NSDQ one hundred. is that you need to be listed on the stock exchange, but also be a financial Okay. All right, I'm starting with the hard hittding questions Quion number two This is an index that has been thought of as a tech forward, innovation based I'm sure there are tons of companies that want to be included in the NASA one hundred for reasons that are very obvious. It's got the brand recognition and the cache and then of course, there's the the fun flows, which don't hur Um Is it simply the top market cap companies or is there more to it than that There is a little bit more to that. With the rule changes that occurred. it used to be just a straight market cap weighted index with certain rules in place to keep it compliant with registered investment company concentration rules But they they essentially switched to a lesser of function where they're looking also and taking account free float as more of a weight determiner, especially for some of these companies do have a lower free float It did get a little bit more complex, but at the end of the day, The largest companies are still getting the largest weights How do you make sure that the integrity of the intent of the NASDAQ technology is maintained. So like what if For example, the most born company in the world wants to go from I't know the New York Stock Echange over the NastdA. and you say Hey, wait, get out here Walmart, no offense. likeike this o actually you know what? Walmart is pretty innovative. Whatever. Chlorox, like the astoggy consumer staples company. what if they want to come? wouldould you welcome the business? L how would that work? Yeah, so you're exactly right. With the methodology of the NSDAQ one hundred being as simplistic as it is. A company like you mentioned Walmart moving in in January because they switched listings of Clorox wanted to switch You know, name any of these consumer stable companies that I think a lot of people wouldn't necessarily associate with attch heavy NASDAQ one hundred they would be included if they're their're market cap. included them, you know, if it was high enough With all that being said though You know, I would welcome it You know, even though NSDAq one hundred has been pretty tech heavy, fiftycent to sixty percent you know, depending on which classification system you're looking at It's outperformed the tech sector, which I think is most interesting. while having forty percent less of that exposure But I think overall, what NSDAQ is really striving to do is to have the NasSDAQ one hundred be not just the large gap growth benchmark but just large cap in general for the U.S market. So I think listing on NSDAQ has shown to do very well for your company if you do that overall You also see NSDAQ winning the IPO race through the years and obviously getting notable changes like Walmart to their exchange overall. So I would welcome those sort of companies to come in because I'm very confident in the companies that are already there providing that tech innovation weight overall ed, I'm sorry. I've got just one word and I was gonna let you speak, but this is very timely. We got an email from a listener Um, and it said The subject line was core portfolio change. And it said, hey guys, most people probably use the S andP five hundred as a core piece of their portfolio The investing world is always changing Dow Jones, S andP. now we have the NASA one hundred I've always done sixty to seventy percent S andPS my core U that have my randoms Okay. lookingoo back at the last twenty years since tech has taken over the world, the NASAC one hundred has outperformed by for to five percent over twenty years. The NASA one hundredun is more concentrated, of course, is's a time to split our core portfolio to fifty fifty NASA one hundred to SMP And the truth is, Paul I didn't respond to this person. h even though we are We are branded as personal emails, personal responses I kind of Not to be reote to the emailer because we love all emails. Ben, do you agree this is like an email from twenty eighteen Where do you think it's a little too late for that? What? Like ye, Listen, the S andP five hundred is SP five hundred peopleople People have been thinking more and more about the NASAC for a long time now I think the brand is there probably to be a more core position. Paul, I'm sure you hear that a lot. like that most a lot of investors do have that as anchor in their portfolio now Correct. one hundred percent. It's been a pretty consistent narrative that we've seen. I mean NASDAQ one hundred QQ and QQM account for twenty seven percent of all AUM within the large cap growth ETF category in the US We are the five hundred pound gorilla there within that space And that is because more and more people, especially since COVID, have used the cues and QQQM as the core part of their portfolio So it's a quarter of all large cap growth money is now somehow tied to the NAAak one hundred. Is that be said That's correct. Wow. wow. That's probably big than I thought So a lot of people obviously are already there. Let's talk about the rocket ship in the room Are you surprised at the degree to which people have seemingly cared about index inclusion rules in the past month or so. becausecause there obviously are people who have very strong opinions about this And people are it seems like a lot of people are maybe learning on the fly about how this all works when it comes to a large IPO. I'm just curious if you're surprised at the degree to which the attention that this sppaceX IPO has gotten in terms of index inclusion Yeah, I would agree with that statement overver and over been. like this has been one of the busiest times that I've had in my job covering the ceues for the past six years now that I've seen, you know, I mean twenty twenty three was pretty busy when NazAq one hundred went through a special rebound, but that was about a week and a half long This has been pretty consistent over the last month. and I think it's a convergence of a few different timely topics, right? Obviously everyone loves talking about Elon Musk, what he's doing, whether you like him or not And then valuation of SpaceX you know, before pre IPO, people were saying one point five to two trillion. We haven't seen an IPO like that before So I think all those different things have raised interest among investors along with the change of the fast century rules that NASDAQ released in May There was a certain cohort of people who Do not like Elon Musk, do not like the inclusion Oh, you're changing the rules I think this rule change is frankly overdue Now, maybe it hasn't been necessary. because Private companies have been staying private for so much so long that we haven't had IPOs of this size But I think it wouldd be weird if the NASA one hundred was not In The index Um, wait, what did I just say Huboo AX in Nack What did I say? I said Nazak Yeah. okay I think it would be weird if a multi trillion dollars market cap company was not in the index And I think what NSDQ, I know you work for NSco. What NSDAak what what what they're doing with the NASAC one hundred In terms of making sure that It is not overreresented in the index and adjusting for the float makes a lot of sense. So it's not like investors have to swallow two trillion dollars of Elon Musk C you talk about what that inclusion is going to look like and how You all are adjusting for what's available I really appreciate how NASDAq approach fast entry in general And as you alluded to, Fast Ery isn't something that's completely new. Other index providers have had it, right? Russell MS CI Chris They all have fast enturry provisions U so its it's nothing new And Michael to the point that you made, I would be surprised if a company like SpaceX, which definitely has the pedigree of being a NASq one hundred company wasn't included So throughout all the conversations I've had over the past few weeks, it comes down to, okay, how iss it going to be weighted? and Basically looking at free float versus total market cap. And if that free float number is less than one third of the total market cap NSDAQ applies a flat three X multiplier to that free flat to give you the modified market cap right. So I know that's a lot of jargon. What does this actually look and feel like with SpaceX. So SpaceX today has a free float approximately eighty five billion. Their total market cap is closer to you know, one point seven five to two trillion So that is definitely under that one third threshold You multiply that eighty five billion times three, which gives you the weight comes into the NASDAQ one hundred, which will be after the close on july seventh. They just made that announcement on Friday And it'll probably be at a weight between one point twocent to one point four percent deepending on how the market moves, not just SpaceX, but the other components of the NASDAQ one hundred as well So the amount of attention that it's gotten The inclusion, I'm glad that it's there because you have a lot of individual investors who are saying maybe I should just go out and buy SpaceX, but When you see Space X trade between one hundred and fifty and two hundred and twenty nine dollars in the first few weeks of trading It's like, how do you commit serious capital to that without worrying about the extra volatility that might come with it NazAq one hundred allows, you know at a pretty decent weight compared to some of these other indexes to give you exposure to a company I'm curious maybe you could walk us through some of the history. L how flexible Are these committees? have these committees been in the past? I think some people think that it's just totally robotic and there's rules that you follow and you have to follow the rules. But obviously, the market environment is changing and the index providers are changing with it. Just maybe walk us through like how much flexibility there is in this process. An index like NASDAQ one hundred, there's a phenomenal amount of flexibility, but I think what's more important There's a great deal of transparency you we know Any investor could go and look up the methodology of NazAak one hundred and see if a company is going to be included or not if it lists newly and I if it's a newly listed IPO just to contrast that versus S andP, which is a fantastic company, but they rule that they are not adding a fast entry provision. you know, they did that last month through a consultation process. and They still have their twelve month seasoning process. They also have a profitability screen and then also a committee Right? So I think when looking at these different ETFs, you have to assess and if investing in IPO is important to you We've also heard the exact opposite where I don't want to invest in these newly IPOs because they're not profitable, right I think you need to take all those different things into account about how these different index providers approach it And she's the one that aligns best with how you think So one of the big narratives around the private markets is the fact that these companies are staying private longer, than it is taking much longer to come public You know, we're talking about multiple potentially trillion dollar IPOs this year. We've already had one And some people think, well, hey, we're being left out And it's kind of funny to think I think over the last fifteen years, the NASDAQ one hundred I look today is up almost twenty percent per year. So it's like nineteen percent in change. We're recording this in late June Do you think that investors really are missing out a lot by not being not having some of these private markets come public earli Or do you think that really because the massive behemoths have have in megas have had a big part in all the gains that it really wouldn't have as big of an impact as people think Where I would say we've probably seen the greatest effect Ben has been within smallall cap, right? I mean, if we rewind the clock twenty five years ago traditional path, company goes public They're probably listed as a small cap company or a mid cap company and they make their way up I think you can attribute that of the reason smallmall Cap has underperformed over the past ten, fifteen years Um But I think overall When you think about investing in private markets, it's a lot more complex than investing in public markets You also are seeing more and more companies like Inesco and other asset managers providing other ways to gain access to that. which I think is most interesting Now whether or not that's still an appropriate investment for that investor, you know, only they could decide that probablyroably with the help of a financial professional because they are more complex What I appreciate is how there has been more availability to access these private markets During this time, while you see all these different valuations come out about whether they call them unicorn companies or these private companies that have grown in valuation at the end of the day, we still have broader market indexes performing very well throughout the time. So I wouldn't necessarily say investors have missed out especially over the last three years with The trade primarily being tech driven. AI focused There's so many different investments out there available as a way to slice and dice that Um And I think appropriately As these companies do go to go public, they are being included Why do you think the NSDAQ one hundred has outperformed some other tech benchmarks? part of me thinks it's sort of random But the app form it seems to be persistent enough that it's and the size, like for to five percent a year makes me question that assumption thing random Like, is there anything Is it just market caps beinged and everything? Is it that simple Well, I think over the past, Three or five years, right Everything's done well, even though NSDaQ one hundred has returned just under twenty percent per year. Right, where I think it comes down to dispersion in the market, right? How concentrated is that performance And where is the performance being driven from Right? We've had a handful of companies up until this year, drive that strong outperformance. They are NAasSDAQ listic companies. They've grown to be very large, right? And y contributor of that outperformance. But I think when you look at it from a longer term basis what you generally tend to see are more innovative and technologically focused companies list on the NAazX Stock Exchange We quantify that by looking at how they focus on R and D, what sort of patents they're filing And what we really feel what has driven that longer term outperformance is these companies' abilities to innovate and already have a product in place when there's a seismic shift that happens with how consumers behave You look at COVID, for example, right? when the world changed overnight, world shut down companies inside there that were well positioned for that work from home environment. If you go back in time though and take a look at whether it was the Dawn of the internet the dispersion of smartphones and how they affect our lives, social media which obviously is more of a plan like ad revenue NSDAQ one hundred companies are at the center adjacent of all those throughout the twenty first century You have these companies who have become the conglomerates of the twenty first century as well. So know I think of a company like Amazon which started off as an online bookstore tryrying to put bars and Noble out of business They're now one of the largest web service providers in the world Right? You know, so they went from two different areas of the market and where they're focusing You know, and it's They saw the market trend and have moved there pretty well That's pretty consistent through many of these names that are NASDAQ one hundred heavyweights which most importantly has driven the strong fundamental growth that we've seen in the companies. We all know that Although short term price may fluctuate, what drives long term perform is its fundamentals Pice follows fundamentals You see earnings and revenue growth outpaced out of the S and P five hundred. and the Russell one thousand growth, which is the true driver of the Ler term outperformance, you've seen Michael. It is interesting because I did this a couple of months ago where I looked at I mentioned the NASAQ one hundred is up almost twenty percent per year, lastess fifteen years. I think earnings were up fifteen percent per year, fourteen percent. So it's like you're right, the fundamentals have been driving this. Is there any part of you And I'm as you to put your Randless on here That's concerned that the performance has been so strong in the NSDAQ. that going on, you know, fifteen, twenty years of high double digit perform does that concern you at all from a cyclical perspective? The prevalent outperformance that we've seen from Qs and QM have made my job a lot easier through the years. and that's one thing that does make me worry, right? I mean, if you think about it in the context today where I'm sure you're hearing from your listeners, right This is another tech bubble like we saw back in nineteen ninety nine and two thousand Right? You know, you have only a few companies driving the performance. you know, whether it's government intervention or regulation or any other numbers, you know, whether it's credit and did the risk with that large CapEx spend these companies are doing sureure those are concerns that I do have. You know, what I really rely on though is that I'm just when we run those fundamental growth numbers R? We're just not looking over the past few years. We're looking at long term trends that have taken place over the past twenty five years. You talk to NSdDAQ The index was incepted back in nineteen eighty five, technically. QQQ didn't come around until nineteen ninety nine That fundamental growth story even with the tech bubble still in place going back further Right. So these are longer term trends in the market where of course, you're going to go through periods of outperformance, underperformance with anything, but when that does happen I'm confident with the value that these companies have shown balance sheets that they have and the cash flow they've produced Allright, I'm looking at the holdings and this surprised me. In order Then listen up. Nvidia one Apple two No surprises there Number three Micron. Number four Microsoft Number five Amazon Number six, seven, eight nine, ten, eleven, twelve Number thirteen Meta Micron is more than twice as large in the NASA one hundred as meta And Pa P put my Sherlock Holmes h on here for a second. Is that because Mark Zuckerberg owns so much that is not it is not counted in the free float adjustment Not necessarily. what I would say that comes down more to is just where Ma has been and the earnings that we've seen. If you think back, Q one's earnings announcement from Meta and where they've been, they've obviously been very vocal and they have spent a bunch I'm trying to have their AI build out come to speed with I think There was announcements coming to like invest for disappointment I think another key factor specific to meteta that we've seen is taking a look at their CapEx versus their free cash flow And their free cash flow started to turn negative back in Q one. with the Q one earnings announcement Paul sorry to cut you off. I'm talking about the waiting of the of the companies in the index, what does What does all of the fundamental stuff have to do with it. is Is it aren't we talking Met capap We are, but I mean, that market cap is a a pure function of the per share price, right? And if investors aren't liking their earnings announcements They're not liking how much they spend. They may look at free cash flow and say, that concerns me a little bit and they start selling Meta Right? That's going to affect their total market cap and affect their weight within Q and the NasDAQ one hundred. Michael, youre thinkking that meta should be a bigger Bigger waiting Meta's marker cap is larger than Micron And yet Micron is a five point seven percent weight. This is as of june twenty seventh Micron is five point seven percent, and meta is two point six percent It's more it's Twice as large, more than twice as large Last I looked, Meta's free flow was around eighty per to eighty five percent So I don't have microns off hand What you'll see though in between quarterly rebalances is that You may see physitians that have performed really well or really poorly move slightly, right? And at the quarterly rebalances NA NazSDAQ will rerun the waiting methodology, right, notot necessarily make new additions or subtractions but rerank them Well, another example of this is like not to belabor the point, but Walmart is the same size as applied materials. basically, it's thirty basis points larger But the Walton family own so much of Walmart It is not itss full market cap is not in the index That is correct So Paul how much So when you do these quarterly rebalances for the NAaza one hundred, how much turnover is there typically when that happens A few percentage points, not that much. I mean, on average, QQQ and QQM are turning over anywhere between six to eight percent on an annual basis Right. So it's not a huge number with most of that five to six percent coming in the annual reconstitution So that's where most of it is coming from. The quarterly rebalances are primarily I just to make sure that the integrity is in line withue with the methodology How much interest is there And I know this may be a tough question to answ Answer Is there a lot of interest in the Js, the next generation, the juniors orr people just more paying attention to the megas because that's what's worked for so long There has been more interest within QQQJ through through the year where we're actually seeing organic flow come into it. And I think it is because if you think back Basically since two thousand October of last year Right? Whereas Tracks within certain parts of the AI trade showed up questions about private credit, how's CapEx being funded along with software getting smmack pretty good. People have started to diversify Obviously what we've seen happen in Korea And really what's been happenving within QQQJ over the past ten months is that AI trade starting to broaden out outside of GPUs, right? Everyone was so focused on GPOs from twenty three through end of twenty four, twenty five. The move, we saw memory prices start to rise back in twenty twenty five pretty. pretty dramatically, not just like RAM prices but also storage prices as well. where you see companies like Sandis, Western Digital, Seagate perform very well. companies that were once in QQ QJ. So I think what we're naturally seeing in the market and it's expressed very well, I think, in the Qs and J is that With any new technology, you do see a broadening out. I think at the end of the day, we are going to see winners and losers I think concerns over how Mag seven's been performing along with concentration in Megaap in general, more people have been broadening out And now that performance is there and has been there for the past twelve, eighteen months, people have been moving more into J Paul for people who want to learn more about the Qs or InScoo and their whole suite of innovative ETFs, where do we send them G go to investco. com Thanks, Paul. Thank you All right, thanks to Paul Remember check out Inesco. com to learn more about the NTX one hundred ETF and all other other ETF's. emmail us animal spirits at the compompound News. com