When will US tech stocks start working again? We are asking this question today because, over the last year, the NASDAQ Composite is down 5 percent and the QQQs (NASDAQ 100) are down 1 percent over the same period. These are not the sorts of returns one expects from disruptive tech companies. But … Here we are nonetheless, with the S&P (up 5 percent in the last year) handily beating the Comp and the QQQs.
The chart below of trailing 1-year returns for the NASDAQ Composite back to 1982 shows that this sort of lackluster performance is actually quite common after an outsized, post-recession gain:
- We have noted the peak annual gains in the NASDAQ after every recession (gray bars) in green on top of the rolling annual return line: 1983 (+87 percent), 1991 (+64 pct), 2004 (+56%), 2010 (+63 pct) and 2021 (+80 pct).
- At some point in the following 1-4 years after these peak post-recession gains, the NASDAQ always prints a negative annual return, as we show in the red notations below the rolling annual return line. These drawdowns can be very pronounced (1984’s -25 percent), or quite shallow (1995’s -5 pct, 2005’s -1 pct, 2011’s -2 pct), but they always occur.
- After that partial giveback in performance, the NASDAQ then starts to work better through the rest of a market cycle (i.e., until the next recession). As the chart shows, results will vary from insanely but unsustainably great (the late 1990s/Feb 2000 dot com peak of +100 pct) to just “OK” (the late 2000s 0 – 20 pct annual returns) to quite solid indeed (2014 – 2019, 20 pct annually save 2016).
So, is the NASDAQ ready to start its customary mid-cycle move – somewhere between +10 and +30 or even 40 percent forward annual returns? We think it is premature to make that call for 3 reasons:
- Because so many NASDAQ stocks were uniquely positioned to benefit from the pandemic, the Comp had an above-average snapback rally from the March 2020 lows. The March 2021 peak of an 80 percent return is higher than the average of 65 percent during the prior 4 post-recession recoveries. We may need to see the NASDAQ give back more of those gains, as it did in 1984 (-25 pct) after 1983’s strong rally (+87 pct).
- The Federal Reserve is set on bringing down inflation by raising interest rates, and this will be a headwind for growth stocks until long term yields stabilize. We mentioned in “Markets” that we believe 10-year Treasury yields are heading straight to 3.2 – 3.7 percent. With current yields still below 3.0 percent, valuation pressures will remain if we are right on our rate call.
- While we don’t agree that Fed policy will create a recession, we absolutely do believe rising oil prices still could. Recessions are not kind to the Comp; every single gray bar in the chart above shows negative 20 percent annual NASDAQ returns. If the Russia-Ukraine conflict were settled tomorrow, we’d certainly recommend loading up on the Comp. For the moment, however, we cannot.
Takeaway (1): the NASDAQ market cycle works in a very specific manner, and the 2020 – 2022 period has been no different. The last year of zero returns for the Comp are not an anomaly or a market mispricing. They are normal and reflect typical investor behavior coming out of a recession: a snap back from the lows followed by a lull as fundamentals can no longer live up to very lofty expectations.
Takeaway (2): some NASDAQ mid-cycle periods work better than others, and we’re cautious on how this one will turn out. Between aggressive Fed policy and geopolitical risks, we’d rate 2022 as below-average for the sorts of animal spirits that typically create mid-cycle tech stock rallies. Again, that could change if geopolitics change, but they have not yet done so.
Takeaway (3): we strongly prefer super cap “Big Tech” to the more speculative parts of the NASDAQ Composite. In the current environment, large profitable technology companies should outperform those with spottier financial performance and/or balance sheets. This is partly due to the mathematical effect of rising interest rates on valuations, but also because steady profits most often come from a company’s competitive advantage. Ultimately, the ebb and flow of tech stock cycles is due to the market’s constant re-evaluation of strategic winners and losers. Sometimes potential future winners do best (as they did in 2020 – 2021). And sometimes – as now, we believe – current winners outperform. The next “new new thing” will have its shot when risk appetites are high once again.