Nasdaq 100 analysis: Can Fed interest-rate hikes continue to slaughter tech stocks?
06:45, 15 September 2022
The Nasdaq 100 index (US 100) had its worst session since March 2020 on Tuesday of this week, plunging 5.6% in response to another strong US inflation rate print, which came in at 8.3% year-over-year in August, shattering expectations of an 8.1% increase.
The unexpected rise in inflation has prompted markets to anticipate a more aggressive Fed policy tightening in response to the persistently high cost of living.
Investors have fully priced in a 75 basis point rate hike next week, but November's FOMC meeting odds also favour such a hike, which could bring US interest rates to 4% in less than two months.
Since the beginning of the Federal Reserve's rate hike cycle in March 2022, the Nasdaq 100 has been battered by steadily rising US real yields, a barometer of the Fed's monetary policy tightness.
After falling 26% so far this year, could higher US interest rates cause the Nasdaq 100 to fall even more?
What is your sentiment on US100?
Chart: Nasdaq 100 and US real yields have a strong and inverse relationship
Nasdaq 100 (US 100) index vs US 10-year real yields – Photo: Capital.com, Source: TradingviewWhy do US interest rates weigh on technology stocks?
The Nasdaq 100 index (US 100) has moved in the exact opposite direction of US real yields, which represent the difference between nominal Treasury yields and market-based inflation expectations, or Breakeven yields. Real yields serve as a measure of the Fed's rate tightening aggressiveness.
The 30-day correlation between Nasdaq 100 and US real yields is currently at -0.83, indicating a strong and inverse negative relationship.
Since mid-March, US real yields have risen dramatically, from -0.7% to around 1% as of writing, reflecting increased expectations of a more stringent Fed's monetary policy.
This means that the nominal yield on a 10-year Treasury (3.45%) is currently about 1 percentage point higher than the market gauge of inflation expectations for the next decade (2.45%).
Positive real returns on a safe asset like US Treasuries undoubtedly act as a deterrent to investing in riskier assets like stocks.
In comparison to stocks in other industries, technology stocks are more sensitive to changes in Federal Reserve interest rates. Technology companies embark on long-term growth projects that require significant financial investments. When interest rates rise significantly, it becomes more difficult for tech companies to meet their long-term goals, and their expected future cash flows fall as the cost of money rises.
This causes tech stocks to fall more than the broader stock market. The Nasdaq 100 has substantially underperformed the broader S&P 500 (US 500), which is down only 17.7% year to date compared to -26.5% for the tech-heavy index.
Chart: US S&P 500 vs Nasdaq 100 year-to-date performance
Nasdaq 100 index vs S&P 500 index: 2022 performance as of September 15, 2022 – Photo: Capital.Com, Source: TradingviewNasdaq 100 outlook: What can we expect from here?
If interest rate expectations continue to rise, the Nasdaq 100 index (US 100) is likely to experience further declines as the expected cash flows of technology stocks contract.
After the US inflation rate continued to outperform market expectations to the upside this week, markets have already fully priced in a 75 basis point hike at the FOMC meeting next week.
The Nasdaq faces downside risks from rising expectations of stronger Fed hikes in November, December, and February of next year. Odds for an additional 75 basis point hike in November are rising faster, which could then bring US interest rates to the 4% mark ahead of the December meeting. Stronger rate hikes could weigh further on the tech-heavy Nasdaq index.
However, there is a limit to how long high interest rates can continue to depress the value of technology stocks, and that limit is set by the risk of a recession.
Paradoxically, the arrival of a recession would be good news for the Nasdaq 100.
Interest rates are the most damaging factor to technology stocks, but a severe recession could halt the Federal Reserve's aggressive rate hikes. The higher Fed interest rates go, the stronger the risk of triggering an economic downturn.
However, for this scenario to truly reverse the Nasdaq 100, we must also see an undeniable drop in inflation. But, given how inflation is so firmly entrenched in the whole consumer basket right now, the idea that inflation will drop sharply is still a long way off, and even in a recession, it will probably take longer to come true.
Nasdaq 100 price target: Is 10,000 the bottom?
Nasdaq 100 historical drawdowns from peak – Photo: Capital.com, Source: KoyfinWhen we examine past drawdowns of the Nasdaq 100, we start to see significant drawdowns levels.
We are now down -26% from the Nasdaq index's peak, while the drawdown was 30% in June of this year.
A similar decline for the Nasdaq occurred in 1990, when the index fell 32%. In 1987, however, the Nasdaq 100's drawdown was stronger (-40%).
This -40% drawdown has the potential to act as a guide in locating the bottom that the Nasdaq 100 could reach. By assuming a 40% decline from the Nasdaq 100's peak in November 2021, we would be close to the level of 10,000.
I would not use the Nasdaq's extreme drawdown (-81%) between February 2000 and October 2002 as a guide, because that market turmoil was caused by the bursting of the dot-com bubble. Today, tech stocks do not have exorbitant valuations comparable to those in the early 2000, nor is there the same level of euphoria that existed then.
This key psychological support of 10,000 would bring the Nasdaq nearly back to pre-Covid levels, effectively wiping out much of the rally fueled by the pandemic's ultra-accommodative monetary policies.
Nasdaq 100 index, chart as of September 15, 2022 – Photo: Capital.com, Source: TradingviewNasdaq 100 technical analysis
Markets in this article
Related topics
