Talk Your Book: Is the Nasdaq 100 in Another Bubble?

0:00Ben Carlson:Today's Animal Spirits Talk, your book, is brought to you by NASDAQ. Go to nasdaq.com to learn more about the NASDAQ 100. Research on the NASDAQ, all these things, nasdaq.com to 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 Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:34Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:42Ben Carlson:Welcome to Animal Spirits with Michael and Ben. On today's show, we talk to Mark Merricks. Mark is the global head of Index Insights for NASDAQs. We talk about the history of the NASDAQ 100. I learned a lot on today's show.

0:53Michael Batnick:There's new rules about inclusion, which makes sense. Listen, It's not 19-whatever anymore. Things have changed. And so the criteria for inclusion has to be modernized and updated. And it was when we got into that.

1:06Ben Carlson:Mainly because companies are staying private longer and coming public at bigger valuations.

1:10Michael Batnick:Right, right, right. It's not the 2022 NASDAQ 100 anymore, Ben. New things have come to light. And it's been a minute, but we're having that conversation again. That conversation being, is this 1999 all over again? And so they've done awesome work. They published a couple of papers about the differences between the index construction in 1999 and today. We got into all of it.

1:35Ben Carlson:A lot of really good charts. There's some data that there was a data point in this podcast that blew my face off. There's a ton of great stuff in here about now versus dot com bubble, history of the Nasdaq 100. We did all that and a lot more with Mark Merricks from Nasdaq.

1:53Michael Batnick:Mark, welcome to the show. Thanks, Michael. Great to be here. So we've spoken with you before. We speak about the NASDAQ 100 seemingly every week. I was like, oh, what are we going to talk about? It's, you know, only so many times we can mention it. And I was wrong because there's so much talk about because there was a lot happening in the NASDAQ 100 ecosystem. Famously, NASDAQ shared rights with Invesco to launch the Qs back in whatever year that was. Was it, did it launch in 1999 or 2000? 1999. Yeah. Unreal. There was news recently that both BlackRock and State Street are also going to have access to use the name of the NASDAQ 100.

2:35Michael Batnick:And last week, I was reading a blog post from this guy, Mark Rubenstein, who writes a wonderful post called Net Interest. And he was talking about some of the potential rule changes, which maybe we'll talk about today to get into the NASDAQ 100. Of course, the market structure is radically different today than it was back when the rules were invented. So maybe a facelift makes sense. But one of the things that Mark said was in the past 12 months, it earned, meaning NASDAQ, it earned$854 million in licensing fees, of which around a third are from the Qs. So you guys have this wonderful post looking at, what's it called?

3:15Michael Batnick:The NASDAQ 100 ecosystem, the evolution to power investor choice worldwide, where you share just how gigantic the NASDAQ 100 ecosystem is. And on top, you've got this big black bubble that's$1.4 trillion with webs going out all over the place showing what that encompasses. So the Qs as of whenever this was published,$351 billion. The QMs, you've got mutual funds, you've got derivatives. I mean, the structure notes. This is a massive, and I'm not breaking news here. This is a massive, massive ecosystem. And I don't even have any questions for you. This is a terrible lead-in. Where should we start?

3:53Michael Batnick:I'm asking you, the guests, where should we start? I mean, I'll start with, you know, you're saying it's not breaking news in the sense that, you know, this has been building for years now. And we just happened to write a paper on it for the first time a few months ago. My team did, and we're sort of the global index insights team at NASDAQ. I think, though, it is news for a lot of everyday investors when they sort of look at the numbers on the page for the first time and actually try to think about what it means to have a trillion plus ecosystem around this index, given that, you know, like you said, 1999 was really the first major product launch for most types of investors.

4:35There were there were products in the option space before that. But 1999 was that first ETF launch. And over the last several years, I would say, is when things have really gotten into high gear in terms of all these different flavors of accessing the NASDAQ 100 through ETFs, which is such a great incubator of creativity in terms of product development and bringing different types of strategies to different investors. Right. And then that's sort of really only one half of the story, right? One half of the chart that we came up with. The other half is everything else that's happening in the derivative space, the future space, structured products, insurance products, which includes things like fixed index annuities, registered index-linked annuities.

5:21That is almost half of the pie on its own, right? And so when we looked at this, we tried to think, okay, what's the right way of summing all of this together? Don't pick a single date at the end of the year. There's seasonality with things like derivative notional. Obviously, the market goes through cycles over the course of a year in terms of performance. So we looked at average 2025. What's the average exposure across the entire ecosystem? Cash, assets under management, and things like neutral funds, ETFs, derivatives notional. $1.4 trillion. That was 35 % growth over 2024. and really when you look out at the universe of indexes that are out there, S &P 500 is the only thing that's larger than this as far as we can tell and there's a big gap between NASDAQ 100 and sort of the next tier below it.

6:11It really is in a unique place in its history and evolution.

6:15Ben Carlson:It's like a brand now essentially, right? The NASDAQ 100, it's not just NASDAQ obviously, but NASDAQ 100 itself is now a brand. It's like Nike. It is kind of like that, right? Because people look at it as, you know, I often, when I present on this to different types of investor audiences, I ask people to do a thought exercise, which is, you know, when you look at the U.S. equity market, obviously, it's kind of been two big names now for several decades, NASDAQ and NYSE. And I ask and I tell people to think, OK, if you're a company, if you're Apple or Microsoft or Amazon or whoever, and over the years you've thought about going public and you've shopped around for where to have your IPO and you have these two main options.

6:55There are actually more options back in the 80s and 90s. But let's say there were these two main options and it was a random decision. It didn't matter. It didn't matter where you listed, right? Flip a coin. What are the odds that today you get to a place where the eight largest companies on the planet by market cap are all NASDAQ listed? Yeah, it's not random. It's 0.4 % to flip a coin and get eight heads in a row. That's the probability. So it means something to these companies to list on NASDAQ, given the success of Apple and Microsoft and Amazon and NVIDIA for decades. It also means something now to be listing in a venue where, you know, in any given year, right, NASDAQ is the leader in terms of total listings, new listings, switches.

7:43We had the Walmart switch at the end of last year, which was just a monumental shift in market cap in a single day, close to a trillion dollars switching over to us. And it really now the exchange represents where the new economy sectors, not just tech, but a lot of the consumer discretionary space, healthcare in the form of biotech, some other areas where they choose to raise capital really matters in the sense of signifying to their investors, to the general public, like, hey, how do I think about my company from a strategic standpoint. I want to be innovation-driven, innovation-forward, and I want to be part of this community of innovators that's been built up over 50 years.

8:20I want to list on NASDAQ. That's increasingly sort of part of the PR and the statements that companies release when they list or they switch. And where better to see that than in the NASDAQ 100, where you have those eight largest companies on the planet, not to mention 92 others that we and I think are pretty special too.

8:39Michael Batnick:So the NASDAQ 100, getting back to this bubble that you have, it's$1.4 trillion. Just to break it down, because I think I glossed over that a little bit. Within ETFs, all right, so the Qs are 350, but it's not just the Qs. So the total ETFs that are linked to the NASDAQ 100 is$587 billion. You have$75 billion in mutual funds, which is around the air, but it's still$75 freaking billion. You have$647 billion worth of derivatives, 51 billion instruction notes. And as you mentioned,$52 billion worth of insurance. The flywheel is spinning rapidly because the importance of getting access to this capital.

9:16Michael Batnick:Now, listen, I am, I don't know, 85 % hard to handicap. Overwhelmingly, I believe the majority of where a stock goes, not every single day, but ultimately like over the longer term is driven by fundamentals. Firmly believe that, cannot convince me of otherwise. However, in the intermediary term or whatever, there's no doubt that at this level of capital, $1.4 trillion, getting into this index and getting the flows, of course it matters. You'd have to be a fool to suggest that it doesn't have any sort of impact on brand, but literally like price, just money coming in. Of course it has to matter a little bit.

9:59Michael Batnick:And one of the things that I mentioned earlier in the show is the rules of this index were written a long time ago before anybody who wrote the rules could possibly foresee what this was going to do to the investing landscape. And now you have companies like SpaceX that are on the road to be traded publicly, coming public at a valuation north of a trillion, possibly even close to two. and prior to whatever rules changes are being considered, it would have taken a minute to get into the index. So, can you talk about what the previous regime looked like and whatever is public that you can share in terms of where this might be going?

10:42Sure, sure. So, I'll lay it out for you, I guess, in sort of high level how we used to manage the index and we did implement this set of methodology changes on May 1st. That is now effective, right? And the way we went about that is similar to other methodology updates that we've conducted over the history of the index. There's been a few of those, right? We had a formal index consultation process where we went out to our asset manager partners like Invesco and others, anyone who's in the ecosystem. We went out to a sampling of investors as well to say, look, here are the proposed changes. Here's why we're looking to do this.

11:19What's your feedback? And there was feedback in that process that impacted what we ended up changing and to what extent we ended up changing it. And I can go into some of that in a little bit. But sort of the high-level headline, right, I think that you're getting at is the fast entry thing, which is not something that NASDAQ is alone at looking at. S &P is also looking at it and some others. And I think it speaks to the evolution, again, as you alluded to, of the equity markets over the last couple of decades, which is simply that, you know, when Google IPO'd, when NVIDIA IPO'd, they were not trillion dollar companies, nowhere near that, right?

11:59They were still typical sort of, you know, maybe a couple hundred million in or a couple billion in terms of market cap as they were, you know, transitioning from private to public. Now you've got, obviously, you know, everybody knows this VC has way more deep pocketbooks than they used to have. They're able to fund these companies for much longer, private equity to some extent as well. And just the very nature of, I would say, what it means to be a technology company today or to be technologically innovation driven means that you can scale way, way, way faster in terms of revenue and market value than you used to be able to in legacy sectors.

12:39And that's part of actually a piece of research that we're in the process of publishing in the next week or so. And so you have the situation, right, where companies get super, super valuable before they need to tap the public equity markets. But that ends up being the end goal for somebody like a SpaceX or an open AI or an Anthropic. And we don't know where any of those are going to list. Right. That hasn't been made public yet. I think I have an idea. I mean, you know, people bet on this type of stuff, I'm sure. Right. So you have your own ideas. Right. And so what we wanted to do was, you know, not have an index that takes potentially almost a year to respond to changes like that.

13:18Because what we used to have was an annual reconstitution in December. Once a year in December, right? We rank who are the top largest by market cap on NASDAQ, make a bunch of deletions, make a bunch of additions right around that annual reconstitution event. There were other rules in place throughout the year. For example, if you were too small, if you were less than a tenth of a percent of index weight two months in a row, you would get deleted. as a constituent, you'd get replaced by whoever's next in line to replace you. If a company went private or switched over to NYSE or somebody else, right, that could happen entry year.

13:53Now we have a process that's going to be a quarterly re-ranking instead of annual. And we have this rule around fast entry where you look at the top 40. If you're in the top 40 by full market cap in terms of your ranking, you can be evaluated on the seventh trading day. And if you're eligible, you'll be added shortly after that with all the other sort of liquidity requirements remaining. And so there's other changes to the rules in place here around things like float, where you used to have to wait till 10 % of your shares were publicly floated to get added. And then you'd get added at your full sort of listed market cap.

14:33We looked at that and decided there's ways to improve that. There's ways to sort of scale up your inclusion in the index, if you're still a low float company, until you get to have about a third of your market value publicly floated, then you're sort of, you stop getting scaled up, right? So there's some of these other changes that we made on the margins to, again, make the index more reactive, more representative, more responsive to what's going on in the market.

15:00Ben Carlson:What if you just said, we're going to market cap weighted? Would that just cut through everything? And why isn't it just market cap weighted where you say, hey, we're just going to take the biggest hundred stocks. Well, that that is what we're doing now. That's kind of what it is, what the new rules are, then, I guess. The new rules are. So let me put it a different way. Right. There's a there's a whole separate consideration to how index methodologies work, which is also from the asset manager's perspective, Invesco or somebody else who has to actually track this right and implement and try to stay as close to the index sort of weights and constituents day to day.

15:32right you want to sort of reduce the noise day to day in terms of how much you are trading in and out of that portfolio to ensure full replication or nearly full replication right and so you could in theory do it like every day you could say who are the top 100 ranked companies every single day but then you have market movements every single day and you're trading around that and re-ranking and it's not necessarily the most efficient thing to have it update that frequently but quarterly is actually quite common. A lot of the indexes we've launched in recent years tend to follow more of a quarterly rebalance and reconstitution schedule.

16:10And so this eliminates a little bit of the intra-quarter noise, other than it has this fast entry criterion for the top 40 biggest names. And it also, you know, kind of eliminates this potential situation where, okay, if you just missed the December annual recon and there were no sort of intra-year exits because of companies getting too small or delisting or going private, then you're not sitting out almost a year's worth of potential gains from someone big coming onto the exchange, like a SpaceX, like an open AI.

16:46Michael Batnick:This is, I was about to say overdue. It sounds rude, but this makes a lot of sense. Right.

16:55Ben Carlson:It's common sense. Yeah, you're right. So I think one of the interesting things about when the NASDAQ 100 first came out, the ETF, the timing wasn't great because within, I don't know, less than a year, the NASDAQ went into an 80 % drawdown, right? So the fact that it survived this long - Ben, sorry to cut you off,

17:11Michael Batnick:but you're going to love this one. I saw a tweet today from Cullen that said, if you invested, remember your video or your post, Bob, the world's worst market timer? Yep. Cullen said that if you invested, at the peak. I don't know if it was when the Qs were launched or at the peak, which is basically the same thing. And you held on to today. LOL, easier said than done, but this is the fact. Jack, you compounded at 8.8 % a year for 25 years or whatever, 26 years. Isn't that wild?

17:39Ben Carlson:Even if you include that 80%, I think it was like an 82 % drawdown. But the crazy thing is, if you've been invested for the past 10 or 15 years, you have no memory of that. And you look at it and you go, oh my gosh. And I looked at this this week. In the past 10 years, the NASDAQ 100 is up almost 22 % per year, which is in like rarefied air. It's over 600 % total return. It's close to like the roaring 20s or Japan in the 1980s. The returns are unbelievable.

18:07Michael Batnick:Ben just casually mentioning every other great bubble of our time.

18:11Ben Carlson:But it makes sense in the context of, yeah, there was this huge crash before. And I think if you put those two together, then it evens out a lot. But the returns are just kind of hard to fathom. And I think mentioning those other bubbles, people look back and go, oh, geez, this is one of those. Because if you just look at history, when you have these types of crazy returns and you have the innovation that we've had, the excesses always get taken too far. Everything swings in one direction and then it swings the other way. And like, this is one of those things. So everyone, of course, is now trying to say, all right, the NASDAQ is in a bubble.

18:43Ben Carlson:This is just like 1999. You see those comparisons on a daily basis now. You've got a really good piece about this, asking the question, is AI another bubble? Like, what did you find in terms of the differences here? So there's a lot of differences. I mean, you guys mentioned it, you know, early on that, you know, for investors, fundamentals are the thing that matter the most in the long term. And that is a big part of the story that we tell every single day, which is if you condense down the NASDAQ 100 sort of pitch to a 10-second elevator pitch. The way I explain it to investors is in the 21st century, innovation is what disproportionately drives growth, whether you're a company, whether you're a sector, whether your entire economy.

19:25Sustainable innovation-driven growth is what drives longer-term fundamental outcomes, preferable fundamental outcomes. And that's over the long term how you get equity market outperformance. So when you look at the last 20 years, right, you gave some stats of your own in terms of annualized performance. Last 20 years, annualized performance is around 15 % a year. earnings have been compounding at about 15 % a year on this index for the last 20 years. Right. So when you when you benchmark it against what the fundamental growth has been, actually, you know, depending on the day a couple of weeks ago, you know, when we were still quite a bit lower in the markets more generally, depending on the day, we're actually trading at a lower P.E.

20:05than we were in the mid 2000s.