Nasdaq May Fall as Valuation Stretched Close To "Bubble" Level

Source: IG Charts

NASDAQ INDEX FUNDAMENTALOUTLOOK:

Trading at a 50.4 price-to-earnings (P/E) ratio, Nasdaq’s valuation has reached an inhibitive level
Rich valuation amid rising Covid-19 viral risk renders Nasdaq vulnerable to a pullback
China’s Shenzhen Composite, trading at 31.9 P/E ratio, is also susceptible to profit-taking

Nasdaq Index Outlook:

With a historic 41% three-month gain through June, Nasdaq stock market benchmark has not only erased all of the losses from earlier this year amid Covid-19 pandemic outbreak, but also became the second-best performing major index globally, just behind China’s Shenzhen Composite (table below). Meanwhile, the S&P 500 index (SPX) and Dow Jones Industrial Average (Dow) have delivered 0.15% and -6.61% year-to-date return, respectively.

Major Global Indices YTD Performance (as at 8am GMT, 24th July 2020)

Source: Bloomberg, Dailyfx

Nasdaq’s astonishing performance year-to-date was underpinned by the Fed’s unlimited monetary stimulus pledge, resilience in technology companies during pandemic period, and the prospect of a post-crisis economic recovery. As a result, Nasdaq’s valuation has been propelled to a 50.4 price-to-earnings (P/E) ratio as the index hit historic highs this week. Looking back, a P/E ratio above 40.0 has proven prohibitive for the index previously (chart below).

Nasdaq Index vs. historic P/E ratio 2010 – 2020

Source: Bloomberg, Dailyfx

The two strong pillars of Nasdaq’s rally – earnings resilience and hope for a recovery – are now being questioned by wary investors as a second viral wave hit the ‘sun belt’ states of the US, and swept much of the emerging world. US Covid-19 infections have topped 4 million this week. It seems that delaying the reopening of the full economy is starting to have a negative impact on the job market, which was reflected in this week’s jobless claims data.

As a result, the likelihood of a meaningful pullback in the technology benchmark, alongside the S&P 500 and Dow Jones Industrial Average, seems to be rising. A spat between the US and China over the closure of each other’s consulates in Houston and Chengdu, have further dampened risk appetite.

Gold and silver, as perceived safe-haven assets, have seen their prices surging to 9-year highs this week, boosted by rising demand for safety.

In sum, fasten your seat belt, as volatility in the stock markets may start to rise as we enter into the month of August – a seasonally volatile month. August ranks the second worst-performing month for the Nasdaq in the past ten years, delivering a 10-year average monthly return of -0.19%. Only May ranks worse (-0.38%).