It was just the thing for their Q4
“Deeply funny” was the rave refrain
It was just the thing for their Q4
It’ll be on stands before the holidays
— Father John Misty; Q4
There’s nothing funny about the performance of U.S. equities in 2022. As we close the books on Q3, a few things stand out. At present, the 34% drawdown from highs represents the worst stretch for the Nasdaq-100® Index (NDX) since 2007/2008.
The NDX fell for the third consecutive quarter with another 4.63% drop between July and September., It’s the first time the index has had three straight quarters in the red since the tech wreck of the early aughts. During the Global Financial Crisis, the NDX managed one positive quarter in mid-2008 during a stretch that left it lower by roughly 45% at the bottom.
Between early 2000 and late 2002, the NDX declined by more than 80%, but the composition of the NDX has changed significantly over the past twenty years. A far greater percentage of the constituents are profitable, but the interest rate environment and risk appetite has weighed heavily on tech in 2022.
The Interest in Rates
A generation of investors have become accustomed to historically low and declining interest rates. The cost of capital influences essentially every facet of the domestic and global economy. On the heels of the 2008 Global Financial Crisis, central banks across the world acted to lower short-term rates to bolster highly levered financial institutions and stimulate demand.
The Federal Reserve followed a similar path (reducing borrow rates) in the wake of the COVID-19 pandemic, which pushed the yield on the 10-year to all-time lows around half of 1% in the middle of 2020.
The efficacy is subject to debate, but the impact of its effort to unwind more than a decade of loose monetary policy has rippled across asset classes. If the year ended today, it would be the worst on record for 10-Year treasury returns.
Source: Compound Advisors
According to the St. Louis Fed, 30-year fixed mortgage rates are pushing toward 7.0%. You must go back to the middle of 2007 for a higher average.
Source: St. Louis Federal Reserve
Persistently high inflation measures (CPI), coupled with equity market performance, have crippled domestic consumer confidence. Using data from AAII, the visual below plots the percent of respondents that self-describe as market bulls minus those identifying as bears. Sentiment is decidedly bearish with readings that echo some of the worst stretches of history.
Source: Compound Advisors & AAII
Dollars and Sentiment
Currency markets are inextricably connected to interest rates and the strength in the U.S. dollar puts significant pressure on many emerging market economies. Sri Lanka, Lebanon and Zambia have already defaulted on international debt this year.
Chinese firms (many state-owned) are struggling to service borrowing costs despite being part of the second largest economy in the world.
Are the Federal Reserve governors concerned about exporting some degree of inflation by way of their stronger dollar policy? Will politicians avoid future policy errors like those of the new Truss government in the U.K.?
There’s been essentially nowhere to hide in capital markets this year. Nearly $17 trillion in equity has been trimmed by the move in U.S. debt and equity markets since November of last year. Beyond that, markets anticipate somewhere between 100 and 125 basis points in further hikes before year-end. Essentially, the only indexes that have advanced in 2022 are those that measure forward volatility.
Long As I Can See the Light
There are clearly a variety of meaningful headwinds for investors as we move into Q4. The Fed continues to push tighter financial conditions, which tend to pressure equities. By many measures, the economy is slowing. The housing market is beginning to correct. The war in Ukraine has no clear end in sight. The short-term outlook is somewhere between dreary and desolate. If your horizon is long enough, perhaps we can find the light.
Let’s broaden our attention from the Nasdaq-100 Index to the Nasdaq Composite Index. There have been seven previous 30% drawdowns since the index was introduced in 1971. Ben Carlson, author of A Wealth of Common Sense, highlighted the performance following such declines.
Source: Ben Carlson
Interesting to note that on four of the seven occasions, the Nasdaq Composite found a trough during the month of October. Is it possible we’ll have another tradeable bottom during the month? Time will tell. The average decline works out to ~45%, but it’s skewed lower by the Dot Com implosion. In fact, every average is weighed down by 2000-2002 data. Are we likely to have another “lost decade?”
Source: Yahoo Finance
The NDX closed below its 200-week moving average for the first time since August of 2008. That ~4-year average was tested during the 2010 selloff, but support held. The markets have reversed roughly two years’ worth of advances in short order.
Looking forward, there are two more Fed meetings, as well as midterm elections, before this year will end. Historically, equity markets tend to underperform during midterm cycles, but “seasonality” is positive in Q4 and following Election Day. Will Jerome Powell and company be able to thread the needle with future hikes? Will we avoid a Dot Com/Global Financial Crisis-like decline? Time will tell.
Throughout the year, there’s been a shift in option volumes toward index products and away from single stocks. It’s possible to gain exposure to and/or hedge risk in the Nasdaq-100 Index using a notionally appropriate product. To learn more about our flagship NDX options, the Reduced-Value NQX, the Micro (XND), or VOLQ: https://www.nasdaq.com/nasdaq-100-options-xnd-nqx-ndx-volq/
Originally Posted October 5, 2022 – What’s in Store for Q4 for the Nasdaq-100
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