This is a make-it or break-it week for Nasdaq, with four of the five FAANG companies reporting – Google (GOOGL), Facebook (FB), Apple (AAPL), and Amazon (AMZN) – in addition to Microsoft (MSFT), which is frequently grouped with FAANG stocks.
There is a lot to be said about the massive rally of all major indices since March 23. This rally is clearly predicated on assumptions that the worst of the coronavirus is behind us and that the reopening of the economy will make any negative macro pressures quite temporary. There is clearly a great dose of optimism since among the pressures we are likely talking about are 1) 20%+ unemployment; 2) negative GDP growth – hence, an almost inevitable recession; 3) PMI indicators for manufacturing and services meaningfully below 50, i.e., in contractionary territory; and 4) plummeting consumption and investment outlook. This is just some taste of what to expect and it may not be limited to second or third quarters; these pressures may very well last beyond 2020.
In this note, we are not debating whether the market overall is overvalued or undervalued. We previously addressed these topics in our article on VIX levels and our article on the S&P 500 trends in the post-coronavirus economy. At present, we are discussing the Nasdaq index (which represents a number of underlying ETFs, such as QQQ, QLD ,and TQQQ) as it relates RELATIVELY to other major indices, such as S&P 500, Dow Jones, and Russell-2000.
Why Does Tech Remain Hot?
There have been too many obituaries written for the technology sector over the last two decades. Ever since the famous tech bubble burst in 2000, investors have been cautious around tech stocks, fearing excessive valuations and high betas that inevitably resulted. When the FAANG group came about, there was a love-hate relationship that immediately formed.
On one hand, investors loved those high growth stocks that grew so rapidly, delivering outsized returns and beating major indices around the world. Furthermore, these stocks were household names and it was easy to explain their attractive nature. It seemed that everyone wanted an I-Phone or an Android. It appeared that half of the world was on Facebook, and that three quarters of the world’s population were googling something.
On another hand, these hot stocks were the first names to get punished when things got sour, even when market routs were unrelated to technology. Whether during the financial crisis of 2007-09, European slowdown of the early teens, Chinese pressures of 2015, oil crisis of 2016, or the tariff war of 2018-19 – Nasdaq usually underperformed other indices during those routs. During each of those corrections or market pressures, investors penalized many Nasdaq names for the irrational exuberance that was formed during prior years. At the same time, as with any corrections, there was an implicit understanding to retest some lows and create a buying opportunity.
Nasdaq: Renaissance in the Age of Coronavirus:
At present, we believe that Nasdaq is positioned as the best index, when compared to the S&P 500, Dow Jones, and Russell 2000 indices. This is a truly unique situation: when Nasdaq is recovering not so much based on its beta momentum, but rather – based on underlying performances of its leading stocks. Therefore, Nasdaq, in our view, is currently undergoing a renaissance of sorts against other indices.
We have built a chart that shows major indices below their all time highs (as of the April 24, 2020 close).
Source: Yahoo Finance
Nasdaq is positioned as the clear winner against the other three indices. Specifically:
Nasdaq: Mere 12.24% away from its all time high of 9,838, Nasdaq is winning for the following three reasons: 1) many tech stocks are stay-at-home stocks, such as Amazon and Netflix; 2) many names are tied to TMT space, which functions well in the remoteness age of coronavirus; 3) there is little exposure to oil, travel, or restaurant industries, which are suffering the most during the current shutdown.
S&P 500: At 16.41% away from its all time high of 3,393, the S&P 500 index is undermined by the very industries that we just said are saving Nasdaq: oil, travel, and restaurant. Furthermore, there is pressure from defensive industries, which have been taking a back seat at times since March 23, while not all cyclical names advance. Amazon is a clear leader in the consumer discretionary space, but other names are struggling to keep up in that sector. Further, banks have been under pressure, due to low rates and rising provisions for losses.
Dow Jones: We have maintained for a long time that it’s a fallacy to assign so much importance to the index that tracks only 30 companies, no matter how large these companies are. As the Dow Jones list below indicates, Amazon and Costco – two crucial names during coronavirus – are conspicuously absent. Furthermore, while the thirty names below are fairly well diversified, we are faced with some names that had highly inauspicious moves in recent history, such as Boeing and Caterpillar. Even within tech space: Apple has been doing well recently , while Intel and IBM have been underperforming. In the payment industry, Visa is a ubiquitous winner, while American Express is facing pressures. Within healthcare, Johnson & Johnson is at the forefront of positive coronavirus news, while Pfizer, relative to J&J, is lagging. And, so forth. What we are trying to say is that the Dow index, while having correlation to the S&P 500 and Nasdaq indices, can often be skewed by a name or two. Therefore, it is not always representative or reliable. Having said that, we still expect the index to meaningfully underperform Nasdaq, so the current underperformance by 735 bps is quite representative.
Russell 2000: Finally, the small cap index has been lagging larger indices for nearly two years, but in the coronavirus age this index – made up of smaller businesses, as well as meaningfully skewed toward oil – has been underperforming. It sits at nearly 30% from the top of 1740, which it set in September of 2018. Furthermore, historically, the Russell index has been lagging behind Nasdaq, primarily because smaller firms, some recently IPOed, can be down substantially.
Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.