Bye Apple, Hello Nvidia

Here are some of the biggest stories from last week:

• UK inflation hit the central bank’s 2% target for the first time in almost three years.
• The Bank of England kept interest rates unchanged.
• China reported mixed economic data for the month of May.
• The Chinese central bank left a key interest rate steady for the tenth straight month.
• One of the world’s leading tech ETFs is set for a major rebalancing that will increase its exposure to Nvidia at the expense of Apple.
• Clean energy spending is predicted to be double that of fossil fuels in 2024.

Dig deeper into these stories in this week’s review.

Macro

The Bank of England had reason to celebrate this week, after new data showed UK inflation hit its target for the first time in nearly three years. Consumer prices in Britain were 2% higher in May compared to the same time last year, in-line with economist and BoE forecasts and marking a step down from the 2.3% pace seen the month before. The last time inflation hit the central bank’s target was in July 2021. Unfortunately, it’s not expected to stay at those low levels, with the BoE predicting that inflation will accelerate in the second half of 2024 to reach an average of around 2.5%.

May’s report also showed core inflation, which strips out volatile food and energy items to give a better idea of underlying price pressures, fell to 3.5% – down from 3.9% in April but still elevated. What’s more, services inflation – a measure closely watched by the BoE for signs of domestic price pressures – ticked down only slightly to 5.7% in May, which was above the 5.5% economists were hoping for.

Speaking of the BoE, the central bank left its benchmark interest rate on hold at a 16-year high of 5.25% on Thursday, in a move widely expected by economists. But it did signal that a reduction was possible this summer, prompting traders to bet on a more than 50% chance of a cut at the bank’s next meeting in August. Finally, the BoE said that it expects economic growth to be much stronger this quarter after the sharp rebound from last year’s recession. It now forecasts growth of 0.5% in the second quarter, up from its May forecast of 0.2%.

Moving on to the world’s second-biggest economy, China reported mixed economic data this week, with growth in industrial output slowing by more than expected last month and retail sales beating forecasts. Industrial production rose 5.6% in May from a year ago – much lower than April’s increase of 6.7% and economist predictions of 6.2%. On the flip side, growth in retail sales accelerated to a better-than-expected 3.7%, suggesting that Chinese households may finally be responding to government efforts to boost consumption (although spending still remains weak by past standards). That was welcome news for authorities, who have turned to manufacturing and infrastructure investment lately to offset weak domestic demand, leading to strong exports but also accusations of overproduction from China’s trading partners.

Separately, the People’s Bank of China kept the rate on one-year loans, the so-called medium-term lending facility, steady at 2.5% for the tenth straight month despite a fragile recovery in the world’s second-biggest economy. The decision probably reflects authorities’ preference for currency stability over lower borrowing costs – especially considering that the onshore yuan is hovering near its weakest level against the dollar since November, driven by expectations that interest rates in the US will remain higher for longer.

Stocks

With over $70 billion in assets, the Technology Select Sector SPDR Fund (which trades under the ticker “XLK”) is one of the world’s most prominent tech ETFs, designed to passively track an index made up of tech companies in the S&P 500. But here’s something unusual: while Nvidia’s weight in the S&P tech index currently stands at 22%, it represents just 6% of the ETF. Behind this big discrepancy are old diversification rules meant to protect investors from concentrated bets. Under those rules, the combined weight of the biggest companies – those making up roughly 5% or more of a diversified fund – can’t add up to more than 50%.

Problem is, three firms – Microsoft, Nvidia, and Apple – each represent more than 20% of the S&P tech index. To address this, XLK's approach was to roughly match the weights of the two biggest stocks and then significantly reduce the weight of the third. And so with Nvidia recently overtaking both Apple and Microsoft to become the world’s most valuable company, the chipmaker’s weight in XLK is set to more than triple when the ETF implements its quarterly rebalance at the end of June.

More specifically, Nvidia’s weight in XLK is expected to jump from 6% to 21%, while Apple’s will slump from 22% to 5%. And based on that, the ETF’s manager – State Street – will be forced to purchase $11 billion of Nvidia shares and dump $12 billion of Apple. That represents huge chunks of their average daily trading volumes, which could lead to some big price moves in the two stocks.

The huge shift in XLK is an extreme example of how even passive index funds can diverge from the benchmarks they’re meant to track, especially when focusing on narrow slices of the market. XLK has held way fewer Nvidia shares than the S&P 500 tech index despite the AI giant's mighty surge, leading the fund to trail the underlying benchmark by more than five percentage points this quarter – the widest dispersion since 2001.

Commodities

Global energy consumption is on the rise, driven by factors including economic expansion, urbanization, population growth, and the proliferation of power-intensive technologies such as AI and data centers. Going hand-in-hand with this rising consumption is a huge surge in investments across new generation capacity, electrical grids, fossil fuel production, and more. In fact, global energy investment is set to exceed $3 trillion for the first time ever in 2024, according to a new report by the International Energy Agency (IEA).

Now here’s where things get a bit more interesting: two-thirds of the record $3 trillion invested in energy sources in 2024 will be devoted to clean technologies like renewables, nuclear power, electrical grids, battery storage, efficiency improvements, and low-emissions fuels. The remaining $1 trillion will go to coal, gas, and oil. That means for the first time ever, investments in clean energy will be double the amount going to fossil fuels. Leading the charge is solar power, with investment in the area set to reach $500 billion this year – more than the money flowing into all other electricity generation technologies combined.

This surge in clean energy investments comes even as the era of cheap borrowing comes to an end, with higher financing costs hindering some projects. However, the impact on project economics has been partially offset by easing supply chain pressures and falling prices. Solar panel costs, for example, have slumped by 30% over the past two years, and prices for minerals and metals crucial for the energy transition have also dropped sharply, especially metals required for batteries (like lithium).

But it’s not all sunshine and roses, and the IEA did have some warnings for the world’s policymakers. More specifically, it said that in order to reach the goal of net zero carbon emissions by 2025 and limit global temperature increases to 1.5 degrees Celsius above pre-industrial levels, spending on fossil fuels would need to be halved, while an additional $500 billion per year would need to be spent on renewables.

Next week

• Monday: US consumer confidence (June), US home price index (April). Earnings: FedEx.
• Tuesday: US new home sales (May). Earnings: Micron Technology.
• Wednesday: Japan trade balance (May), UK inflation (May).
• Thursday: Japan retail sales (May), eurozone M3 money supply (May), eurozone economic sentiment (June), US durable goods orders (May). Earnings: Nike.
• Friday: Japan unemployment rate (May), Japan industrial production (May), US personal income and outlays (May).
• Sunday: China PMIs (June).