Nvidia’s Meteoric Rise Forces ETFs to Rebalance and Could Impact Apple Stock, Why?

It is expected that the Technology Select Sector SPDR Fund (XLK) is forced to buy billions of dollars in Nvidia (NVDA) stock, while dramatically reducing your exposure to Apple (AAPL) during the quarterly rebalancing on Friday, as a result of both the chip giant’s meteoric rise this year and complex fund diversification rules.

“The big shakeup is happening (I’m pretty sure),” he said. James Seyffart, ETF research analyst for Bloomberg Intelligence. “By rough calculations, $XLK will have to sell approximately $12.6 billion in Apple stock to buy approximately $10.9 billion in Nvidia at current prices. This operation, American analysts estimate, will occur on June 21.

Matthew Bartolini, head of SPDR America research at State Street, which manages XLK, agreed with Seyffart’s calculations in comments to CNBC.

What is happening with the XLK?

The XLK tracks the Technology Select Sector Index, which is comprised of the stocks of S&P 500 companies operating in the information technology sector. In total there are 65, including the three most valuable companies in the United States: NvidiaMicrosoft (MSFT) and Apple, in that order.

Theoretically, The fund is weighted by market capitalizationwhich means that the higher the market value of a company, the more influence it has on the value and price of the fund’s shares. But the reality is more complex. Due to diversification rules, no stock can make up more than 25% of the fund. S&P Global, the index manager, limits the weight of each share to 23% to give itself room for maneuver.

Nvidia’s meteoric rise overshadowed Apple for a long time, The company that created the iPhone and Microsoft were the only companies in the index that approached the 23% limit. But with Nvidia’s historic gains over the past year and a half, there are now three companies in the index worth more than $3 trillion each. Together, they represent more than 60% of the index.

At first glance, Nvidia’s rise solves the weighting problem. Its weight has increased and therefore reduced the weight of Apple and Microsoft to less than 23% each.

But there is a catch

“The sum of companies with weights greater than 4.8% cannot exceed 50% of the total weight of the index.” This is why Apple, Microsoft and Nvidia have such drastically different weights in the index. If all companies with weights greater than 4.8% together exceed 50% of the index, they are classified by market capitalization, and the smallest have their weight reduced to a maximum of 4.5%.

The S&P Index is rebalanced quarterly, on the third Friday of March, June, September and December, based on the market capitalizations of each stock at the end of the previous week.

With Nvidia’s free float-adjusted market cap surpassing Apple’s after a close race at the end of trading on Friday, The index now needs to reduce its exposure to the Cupertino-based tech giant by almost 80%.

“Any ETF that tracks this index will have to buy NVDA and sell AAPL to adjust the cap difference.”said George Smith, portfolio strategist at LPL Financial on Friday.

What does this mean for stocks? The stakes are high for the owners of each stock. While XLK is a great fund on its own, it may not be the only one that needs to correct course after the index rebalance. Even if it is, changes to just your portfolio could have major implications for the biggest tech stocks.

Any fund that sells or buys billions of dollars of a stock in a week will likely put pressure on the stock price. However, the boost Nvidia stock could receive from the rebalancing may be diminished by last week’s stock split. Now that there are ten times as many Nvidia shares on the market, buyers and sellers can demand more precision in the price at which their trades are executed.

In stark contrast, a sudden avalanche of Apple stock that XLK sells could cause a mismatch between supply and demand, temporarily causing weakness in its stock price.