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Market Overview

Apple And ETFs: Danger Ahead? (AAPL, QQQ, XLK)


The seemingly undaunted rise of Apple (Nasdaq: AAPL), the largest U.S. company by market value, has spurred plenty of conversation about the impact the stock is having on ETFs. To be sure, there are plenty of ETFs with which to gain exposure to the technology juggernaut.

Possibly overlooked in the matter of Apple and ETFs is just how vulnerable these funds could be should shares of Apple experience a deep pullback. Street One Financial President Scott Freeze argues that ETFs are designed to give investors broad-based exposure to sectors, while minimizing individual stock risks.

Highlighting the PowerShares QQQ (Nasdaq: QQQ) and the Technology Select Sector SPDR (NYSE: XLK) as particularly vulnerable to an Apple sell-off, Freeze notes "the extreme weighting of Apple in the weighted Technology ETFs accounts for 10% of the YTD gains and 15% of the rolling 52 weeks gains. So Ex-Apple we see a single digit gain in the QQQ and XLK this year and flat performance for the rolling 52 weeks."

Apple accounted for 19.3% of QQQ's overall weight as of April 3 and 19.1% of XLK's weight as of April 2. The stock receives an allocation of 21.9% in the iShares Dow Jones U.S. Technology Sector Index Fund (NYSE: IYW).

Maybe there's something to be said for an equal-weight approach. As Freeze notes, the First Trust NASDAQ-100 Equal Weight Index Fund (Nasdaq: QQEW) "is up 16% YTD and 7% rolling 52 weeks." Apple accounts for just 1.02% of QQEW's weight and isn't even among the ETF's top-30 holdings. As one example, Netflix (Nasdaq: NFLX) receives a larger allocation in QQEW than Apple.

QQEW has average daily volume of less than 52,000 shares compared to 46.94 million shares for QQQ and 9.19 million shares for XLK, according to Finviz data. Investors using QQQ and XLK for broad-based tech exposure "need to be aware of the perils that holding an ETF with such a heavy weighting of Apple can cause," Freeze said.

"Apple has much more competition for its core products now than it ever did before and questions persist about long term innovative products that will have the same impact as the I-Phone and I-Pad," Freeze said.

Anecdotal, but important examples exist regarding the impact Apple's ascent has had on Apple's market. When the Nasdaq 100 rebalanced in 2011, mainly to diminish Apple as its driving force, the stock fell to 12.3% of the index's weight and QQQ followed suit. But in the span of less than a year, the stock's weight in the ETF has increased by more than 50%. The iShares Morningstar Large Growth Index Fund (NYSE: JKE) had a 12% allocation to Apple just a few days before Christmas 2011. Now JKE's Apple exposure is north of 16%.

As has been noted time and time again by any number of banks and analysts over the past few months, strip Apple out of the equation and EPS growth for the S&P 500 in the first quarter is basically zero. Said another way, the entire market is vulnerable to even the slightest of Apple missteps, be it a disappointing batch of iPad sales figures, an extended delay of the next iPhone or problems with suppliers.

Logically, the broader market's Apple vulnerability carries over to ETFs since it is demand for or selling pressure on an ETF's underlying components that drives the fund's price action. Freeze sees an even more viscous circle playing out while making a sound argument for equal-weight products.

"Should the expected pullback in the market occur, and investors sell out of QQQ and XLK, that will put oversized pressure on Apple itself, and a run of profit taking on Apple would then exert oversized pressure on QQQ and XLK and really hurt investors to a much greater level than ones invested in equal weighted products," according to Freeze.


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