3 Reasons Why Institutions Are Likely To Dump Large-Cap Tech Going Into Summer

by: The Independent Investor

Wow, the Nasdaq is the new stock market. While cyclical sectors like the industrials, energy stocks, and retail names have performed well during the rally, it is hard to debate that the leadership has been in the technology and financial sector. The S&P 500 (SPY) has rallied nearly 10% since the year's start, but the Nasdaq is up even more.

Let's look at the chart.

As we can see, large-cap tech has outperformed the S&P 500 by about 15% during the past several months of the now nearly six-month rally. Obviously, as anyone who follows the market knows, a good part of the reason for this significant outperformance is the movement in Apple (AAPL). Indeed, most technology companies -- even in poorly performing markets like China, with Chinese Internet names like Baidu (BIDU), Sohu (SOHU), and Sina (SINA) -- have outperformed the respective markets these stocks trade in.

Today Apple makes up 20% of the Nasdaq, and most Nasdaq-weighted ETFs have about 20% of their funds in Apple. Essentially, for wealth managers, if you weren't long Apple you were short the stock, since these individuals' performance is graded against a benchmark tied to the overall markets they are investing in.

While the Nasdaq moved to reduce Apple's market-cap weighting in the Nasdaq to around 12% in April of last year, exchanges can't rebalance an exchange every time their biggest-listed company rallies over 30%.

One of the interesting changes that has been exacerbated by the rally in Apple is that the Nasdaq has become much more tied to spending at the retail level. While Microsoft (MSFT) and IBM (IBM) have performed very well this year, now that Apple is bigger than both companies combined, the Nasdaq is as much about retail spending as it is about IT services.

If you look at the Nasdaq today, Amazon.com (NASDAQ:AMZN) and Apple combine to comprise nearly 25% of this market. Currently, the Nasdaq's total market capitalization is around 2.7 trillion. Apple and Amazon's combined market share of the Nasdaq is around 700 billion.

To be sure, Apple's stock has performed very well and may continue to outperform for some time. Still, most wealth managers who control large pools of capital for pension funds own Apple through mutual funds and ETFs since they don't take big positions in individual stocks.

Given that technology stocks tend to outperform in the winter months and the summer tends to be a slow season for retail, it makes sense for institutions to trim or reduce the weighting to large-cap tech at least slightly. Two of the strongest time periods for retail are obviously the back-to-school season and Christmas.

While back-to-school spending usually occurs in the summer, it is not a season that begins until August. Also, even with back-to-school spending, most electronic retailers do the vast majority of their business around Christmas. Apple's next major product launch, the iPhone 5, is also not planned until October, so consumers may hold back on some new expenditures in the third quarter so that they can purchase the new and heavily hyped device.

Additionally, if we look at how most large-cap funds allocate capital, they tend to be weighted to a certain index by percentages. Most institutional investors like to have a stock-to-bond investment ratio, and these individuals also like to have a balanced portfolio within equity markets. Since the Nasdaq has heavily outperformed most of the other major U.S. stock indexes since January by double digits, it is likely that many institutions will need to rebalance their portfolios more than usual as well.

Indeed, while large-cap tech stocks have performed very well up to this point, many of the traditionally stronger summer sectors like energy have underperformed large-cap tech and the S&P 500 during the past several months.

Let's compare the performance of the S&P 500 to the oil service index (NYSEARCA:OIH).

As we can see, while the Nasdaq has outperformed the S&P 500 by a fairly wide margin, sectors of the market that tend to be strongest in the summer -- like energy -- have performed the worst. While part of the underperformance of the oil sector is because of regulatory and legal issues surrounding the BP (NYSE:BP) spill, oil prices are still high, and BP has recently reached a civil settlement with most of the Gulf plaintiffs.

To conclude, large-cap tech has far outpaced nearly every other sector in the market since the beginning of the year primarily because of the performance of Apple.

Still, with tech traditionally a seasonally weak sector in summer and underperforming sectors like energy usually seasonally strong at this time of year, portfolio managers who are heavily overweight large-cap tech will likely look to at least moderately rebalance their portfolios.

While institutional investment isn't the only catalyst that drives sectors and stocks higher, companies with market caps in the hundreds of billions usually require significant new capital to move higher.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.