It’s been a dizzying start to the year for the Nasdaq. The more tech-heavy index has bolted out of the gates, up close to 15% less than six weeks into the new year. 2023 has been the perfect remedy, at least thus far, for investors scarred from the pain of what came before.
The index has jumped as inflation has fallen. While the cost of living crisis is still severe, the market has apparently seen enough from the last few months of declining data to at least conclude that it has peaked.
What this means, of course, is that the all-important Federal Reserve may pivot to a softer monetary policy sooner than previously anticipated. Following the most recent 0.25% interest rate hike last month, Fed chair Jerome Powell indicated that he expects a “couple” more rises before the elusive terminal rate is reached, and the market can begin to dream of cuts.
The Nasdaq was crushed in 2022
While looking at the 15% gain in the above chart sure is pretty, it’s a little uglier when looking under the hood. A zoom out on the chart to capture 2022 betrays how putrid the index has performed.
The Nasdaq is very tech-heavy, which just so happens to be the sector that is the most sensitive to monetary policy. This is due to the concept of “profit” being a little elusive in Silicon Valley. Instead, companies are typically valued on the promise of future profit, with these future cashflows discounted back to the present to form a valuation.
When interest rates were at 0%, this was all fine and dandy. Move fast, break things, as the mantra goes. Well, the monetary chickens are coming home to roost, as rampant inflation has forced the Fed to hike interest rates.
Those fat valuations are not quite as fat when discounted at 5% as opposed to 0%, while profit becomes, well, at least a little important. So down goes the share price – the Nasdaq shed over a third of its value last year, its worst loss since 2008.
Scaling out on the chart shows that the nice little gain is just that – little – relative to the bloodbath last year.
Nasdaq long-term performance
What is interesting when looking at the Nasdaq as a whole is the sheer size of the jump since 2008. The last decade-plus really has been the age of tech, with Silicon Valley start-ups swelling into unicorns and taking the stock market by storm.
From dropping down below $2,000 in 2009, the Nasdaq mushroomed to near $17,000 in late 2021, providing outrageous returns for investors.
But after the 2022 loss, how likely are we to see a further pullback? Or is the bounceback currently thrilling investors bound to continue?
Well, that is the trillion-dollar question. Firstly, looking at the annual returns, it is relatively rare that the Nasdaq has returned two negative years in a row. It has only happened once since 1974, in the aftermath of the dot com boom (when it was negative for three years in a row, ouch).
But that doesn’t really mean anything, to be honest. Bear markets don’t align with calendar years, while the past is not necessarily indicative of the future.
What the Nasdaq’s fate in 2023 will come down to is ultimately Jerome Powell. The sector is intrinsically tied to interest rates, and if inflation does continue to come down and a pivot halfway through 2023 is in play, then the Nasdaq will have slack to make a run.
Then again, there are many variables which could spark downside risk. Russia’s war in Ukraine is still ongoing. The threat of a recession looms large, with the burden of high interest rates felt across the economy. Earnings have thus far reflected this, and who knows what happens down the road?
As indexes go, the Nasdaq is among the more volatile. It’s hard to make a prediction at the best of times, but that rings especially true in this current economy, which is fighting against a cocktail of unprecedented factors. But the most important of all remains this: what will the Federal Reserve do?
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