The conflict in Ukraine has sent global stocks lower but the latest drop in the Nasdaq - among the worst hit - has created some momentum divergence. Is the bottom in?
Latest Nasdaq news
The war in Ukraine has exacerbated the Nasdaq sell-off. The risk-off sentiment in markets generated by Russia’s invasion has increased demand for haven assets and defensive stocks. High growth & tech stocks have been sold in order to facilitate this portfolio rotation.
The underperformance of the Nasdaq index - and the many technology stocks it contains - this year is now well understood. The prospect of higher interest rates coupled with strong economic growth has encouraged people to rotate out highly valued growth stocks and into cyclical areas of the market.
Nasdaq (IXIC) price action
The Nasdaq Composite briefly fell into bear market territory, down 22% from its all-time high over 16,000. The pullback was well overdue following the meteoric rise from the lows of March 2020 that saw the index gain over 140%.
Source: TradingView / FlowBank
Bulls took the opportunity to snap up popular names at a discount and the index has lifted well off the lows. At the same time, a bullish momentum divergence has appeared, whereby price made a new lower low but RSI formed a higher low. This implies the intensity of the downtrend is subsiding.
Source: TradingView / FlowBank
Key fundamental drivers
Ukraine war
The Nasdaq is a high beta version of the rest of the market - it will tend to move in the same direction but at a greater rate. For now, the mood is risk-off because of the war in Ukraine and Nasdaq is among the biggest losers. Should there be a ceasefire or even a peace agreement, the Nasdaq could easily switch to becoming a leader rather than laggard - at least while sentiment is a top driver of the market trend.
The Fed
The prospect of higher interest rates is an ongoing headwind for the richly-valued stocks that make up the biggest weighting of the Nasdaq. It’s difficult for markets to price in this difference while the Fed is still actively buying US Treasuries, albeit at a much slower pace because that activity is distorting the signals coming from the bond market.
It is also unclear how far the Fed will need to go in order to tame inflation. For that reason, it’s impossible to say that Fed rate hikes are fully priced-in. Arguably four rate hikes this year are priced in - but the speed at which they come - and how many come after is not.
However, if the Russia-Ukraine conflict spills over into monetary policy, delaying or reducing the number of rate hikes, the sell-off in the Nasdaq may have priced in too much. Even if stocks remain sluggish owing to the uncertainty of the conflict, the Nasdaq might no longer underperform the Dow Jones and S&P 500 due to monetary policy.
Inflation
Of course, inflation is now the main driver of Fed policy. This week WTI crude oil touched a 14-year high at $118 per barrel, piling onto already decades-high inflationary pressures. Because Russia is a major global exporter of commodities, notably oil & gas - but also aluminium and other industrial metals - the Ukrainian conflict is adding to inflation.
If the Fed concludes that inflation is high and the economy is strong enough, then uncertainty around Ukraine might not be enough to stop, or even pause the incoming tightening cycle.
Valuations
The Nasdaq composite remains richly valued versus other parts of the US market and internationally - but after a 20% dip - it’s much less than it was. The trailing P/E on the Nasdaq 100 a year ago was 38 - now it’s 31 - which compares to a forward P/E of 24. That compares with a P/E on the Dow of 31 a year ago vs 19 now and a forward P/E of 18.
Additionally, unlike many industrial firms that depend on raw materials, the tech firms that make up the Nasdaq have minimal dependency on Russia and future revenue streams are less likely to be affected by an escalation of the current crisis.
Recent history
The last time the Nasdaq entered a bear market was in 2020, from which it promptly recovered. Before that was November of 2018. It dropped 23% in total, including a sharp 17% decline over ten days. It then went on to gain 50% over the following two years before Covid hit the index again.
The lesson for investors based on the last two occasions is to buy the 20%, but it can’t work every time!
Conclusion
The Nasdaq continues to be susceptible to uncertainty and the risk-off environment caused by the Russian invasion of Ukraine in the short term. But looking further out, the impact the conflict has on inflation and monetary policy - given historically high valuations in the Nasdaq - will play the biggest role in whether it will be third time lucky to buy the 20% dip.
