Investors are doubling down on technology, whether they realize it or not.
The annual reconstitution of the Russell Index, a popular benchmark for index funds, will occur after the close of trading on Friday, and the Russell 3000, which includes the well-known Russell 2000 benchmark of small-cap companies and the Russell 1000 group of larger companies, will become even more exposed to a number of top technology stocks with a presence in the burgeoning artificial intelligence market.
Technology's “Magnificent Seven” — Microsoft, Apple, Nvidia, Alphabet, Amazon.com Inc., Meta Platforms Inc. and Tesla Inc. — account for almost a quarter of the Russell 3000's total market capitalization of $53 trillion, according to figures from index provider FTSE Russell.
The seven stocks' combined market capitalization had risen nearly 44% year-over-year to $13.2 trillion as of April 30, the day FTSE Russell ranks companies to determine the composition of all its indexes. The company released a preliminary list of additions and deletions to its indexes in late May and is releasing weekly updates through the end of June.
The annual rebalancing will affect the portfolios of many mutual funds and exchange-traded funds from big asset managers like Vanguard, iShares and Fidelity that are benchmarked to the Russell 1000 and Russell 2000, as well as their related growth and value indexes. Holders of these funds will have greater exposure to technology.
Advertisement – Scroll to continue
The continued rise of Nvidia, the second-best performing stock in the S&P 500 so far this year, and other top tech stocks, has made Russell's large-cap-oriented Russell 1000 Growth Index more reliant on the widespread adoption of AI.Supermicrocomputer, the top stock in the S&P 500 for 2024, will be promoted from the Russell 2000 to the Russell 1000 after the rebalancing.
Nvidia's rise is also influencing the composition of the Technology Select Sector SPDR Exchange-Traded Fund. Nvidia recently increased its weighting in the ETF to nearly 21% of its holdings, making it the ETF's second-largest stock. The ETF's largest stock is Microsoft, at 22%. Apple is a distant third, making up 4.5% of the fund.
So are the major market indexes too reliant on AI stocks? Probably so. But it's worth noting that the market has held up relatively well recently, even as Nvidia experienced bigger volatility after its stock split this month.
Investors seem to be realizing there's more to AI than Nvidia, which bodes well for the large tech stocks in the Russell 1000 Growth Index.
Advertisement – Scroll to continue
The same goes for other incidental movements along the trend.
“Artificial intelligence has moved beyond being a buzzword and is being rapidly integrated into businesses across the economy, from healthcare to finance and more,” Jay Jacobs, head of U.S. thematic and active ETFs at BlackRock, which owns iShares, said in his mid-year outlook.
“Semiconductors, data centers and even raw materials like copper are becoming essential to the growth of AI,” Jacobs said, citing “enormous and immediate demands on hardware, digital infrastructure and power” that AI adoption will create.
Advertisement – Scroll to continue
The Russell rebalance may pose a bigger problem for value managers, according to a report published last month by Patrick Palfrey, U.S. equity strategist at UBS. “The biggest value stocks may come under some selling pressure” after the Russell rebalance as its concentration in growth stocks continues to increase, he said. Fund managers will likely need to sell some shares of companies in value-oriented, cyclical industries, such as financials and industrials, to reflect their new lower weightings in the Russell indexes.
The increased likelihood of the Federal Reserve cutting interest rates this year could “amplify momentum led by large-cap growth stocks,” Jeff Schultz, head of economic and market strategy at ClearBridge Investments, wrote in a recent blog post.
Schultz noted that in soft economic landings going back to 1980, the Russell 1000 growth index rose an average of 16% in the 12 months following the Fed's first rate cut.
Advertisement – Scroll to continue
That's better than the returns of the Russell 1000 Value, Russell Midcap, which includes the 800 smallest companies in the Russell 1000, and the Russell 2000 index. Large growth stocks outperformed large value and midcap stocks during the recession, roughly matching the gains of small caps during the downturn.
So while there's no denying that the stock market is heavily biased towards AI leaders and the tech sector in general, investors don't seem too worried: They're continuing to ride the momentum.
Write to Paul R. La Monica at paul.lamonica@barrons.com
