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Is the NASDAQ Composite in the eye of the storm?

The NASDAQ Composite is at a crossroads. The tech-heavy index is in recovery mode after last month's tumble and could make further gains soon. But constant interest rate rises are on the way.

The NASDAQ Composite just suffered its second-worst January since its inception in 1971. The tech-heavy index fell 8.99%, its biggest monthly drop since March 2020, and just shy of the 9.89% fall of January 2008.

The index was worth 9,731 points on 14 February 2020, before falling 29% to 6,880 on 20 March 2020 during the covid-19 pandemic-induced crash. As the US Federal Reserve opened the purse strings to stave off economic collapse, it struck a record intra-day high of 16,212 points on 22 November 2021. But it then fell 17.6% to 13,353 points on 27 January, as investors worried about tightening monetary policy.

Having now recovered to 14,346 points, two schools of thought have emerged over the index’s future. Either the market has over-corrected and will continue to recover ground. Or the Federal Reserve’s attempts to medicate its $9 trillion balance sheet will send the NASDAQ back to pre-pandemic levels.

NASDAQ Composite: fire-fighting inflation

Inflation is a serious problem across developed nations. In the UK, Consumer Prices Index inflation is at 5.4%. In the Eurozone, it’s 5.1%. But in the USA, inflation is at a staggering 7%, its highest level in nearly forty years. And far from being 'transitory,' Federal Reserve Chair Jerome Powell is now tasked with reversing inflation to its 2% target.

In 2021, the Reserve prioritised maximising employment over keeping inflation stable. But unemployment is now comparable with pre-pandemic levels at 3.9%. And from McDonald's to the Bank of America, US companies are struggling with the labour crunch. Labour Department figures show there are a record 10.9 million job vacancies in the US right now, 2.3 million more than pre-pandemic levels. Accordingly, Powell accepts there is ‘quite a bit of room to raise interest rates without threatening the labour market.’

And he has also confirmed that the central bank’s quantitative easing program will end in March. Moreover, he warned ‘the committee is of a mind to raise the federal funds rate at the March meeting…the economy no longer needs sustained monetary policy support.’

The effect on the tech-heavy NASDAQ could be drastic. Goldman Sachs and Deutsche Bank are predicting five rate hikes this year. The Bank of America is predicting seven, which would bring the base rate up to 2% by the end of 2022. Analyst Ethan Harris believes Powell had even made ‘a compelling case that the Fed should have already hiked rates in the second half of last year.’

NASDAQ growth warnings

While the NASDAQ may have recovered slightly, it’s not out of hot water yet. Morgan Stanley analyst Michael Wilson believes last month’s volatility signals ‘classic bear market action.’ And Jerry Siegel, Professor of Finance at the Wharton School of the University of Pennsylvania, believes a ‘rocky’ stretch for US stocks is far from over. He expects more than four rate hikes, a risk ‘equities are not really priced for.’

And many NASDAQ stocks have issued growth warnings, causing their valuations to plunge. Netflix crashed on news that it only expects to add 2.5 million subscribers in the current quarter, less than half the Refinitiv analyst consensus. PayPal forecasts revenue growth for FY22 at between 15-17%, under Refinitiv expectations of 17.9%. Tesla is aiming to increase production this year by 50% but has admitted this target could be hindered by supply chain problems. And pandemic favourites Roblox, DocuSign, Zoom and Peloton are all falling as the threat of future lockdowns recedes.

On the other hand, Alphabet has just announced a 20-for-1stock split, as revenue beat the Refinitiv forecast by $3 billion to $75.33 billion. And Apple has overcome the supply chain challenges, posting a record $123.9 billion in revenue and $34.6 billion in quarterly profit. Both companies have since seen their share prices rise. But with Meta Platforms and Amazon yet to report, there’s uncertainty over whether the bottom of the market has been reached.

However, investors may be fleeing higher-risk growth stocks for the security offered by the multi-billion-dollar behemoths. Of course, if the market has already reached its short-term nadir, they could be missing out on excellent value entry points. And the NASDAQ’s top 10 holdings make up a third of its value already. Concentrating wealth at the top could make the eventual correction far worse.

The NASDAQ Composite be between Scylla and Charybdis.

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