QQQA - The Bull Case For The Nasdaq

2023-10-04 06:00:00 ET

Summary

• Rising interest rates and coinciding sell-off in the US treasury market have negatively impacted the equity markets.
• Rising oil prices have also contributed to the stock market's decline.
• Despite the correction, earnings expectations for the S&P 500 remain high, which could support the market going forward.

Instead of writing about an individual stock this week, I wanted to build on the theme that I have written about over the last couple of weeks ( 9/25/2023 and 9/18/2023 ). In our opinion, the macro picture of the market remains more important than stock specific risks. The Nasdaq had been rising since early January of this year and despite the recent 8.5% pullback, is still up 26.5% year-to-date.

For better or for worse, I consider the extreme outer limits (i.e. long-duration stocks) of the Nasdaq to be well represented by Cathie Wood's ARKK (ARK Innovation ETF). It is now down -23.6% since its July 19th peak. However, it is still up over 27.0% in 2023. So what led to the disruption of the big advance that the Nasdaq and ARKK have been making since the beginning of this year?

Rising interest rates have been the biggest factor influencing the downturn in the equity markets. I have commented many times on the inverse correlation (for better or worse) that interest rates have with equities. Rising rates make P/E multiples contract and falling rates help them expand. As you can see from the chart of the 10-Year US Treasury Yield below, rates started taking off in mid-May of this year, as inflation remained stubbornly high.

They broke out again in early August and then blasted off after the Fed's dot-plot was revealed after the latest Fed meeting. Rates unexpectedly reached a high, not seen since 2007. This took another bite out of the already weak breadth in the equity markets.

The sudden spike in US treasury rates has also led to a sell-off in the corporate bond space. As you can see from the chart below, the bond market peaked in mid-May, as interest rates were bottoming. The bond market has been sliding ever since. The ten-year treasury ETF has gone down 9.0% over that time. That is a significantly outsized move, for an asset class with historically muted volatility (particularly short-term vol).

From a technical analysis standpoint, the bond market appears to be oversold, and could be finally finding technical support at the current level. Should rates find some support here, this would be a tailwind for equity markets. Specifically for those large-tech names that led during the first half of 2023.

The other near-term development that has hurt the stock market has been rising oil prices. Rising oil prices, will feed through to higher future PPI, CPI, and PCE inflation readings. They started rising in mid-June and have not looked back. However, oil prices appear to be topping out at the current levels, given waning demand in China and the Eurozone. On a go-forward basis, additional non-OPEC+ supply increases in Canada and Brazil are expected to come on line in 2024. Lower oil prices will help reduce future interest rate expectations and in turn benefit equity markets.

The recent equity market pullback can largely be attributed to a contraction in earnings multiples (i.e. P/E ratios). But, what about earnings expectations? After all, earnings/EPS makeup the other half of the price target equation. How have they held up during this current correction?

Earnings have not budged. As you can see from the chart below, we are still looking at record earnings expectations for the S&P 500 in 2023, 2024, and 2025. Realized earnings may not live up to those lofty expectations, but the market will trade on them for the time being.

It seems to me that with an oversold bond market, an overbought oil market, and expectations of record earnings, investors can still make a strong Bull Case for the Nasdaq going forward.

For our current target price for the Nasdaq, see our September 18th article .

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