No sector has been hit harder in this bear market than tech – and tech stocks make up by far the bulk of the Nasdaq Compound index. It’s no surprise, then, that the Nasdaq is down about 25% year-to-date, and the benchmark has been in a bear market for most of 2022.
After the Nasdaq rebounded in July, gaining 12.4%, it fell back in August, down 4.6%, and has headed south so far in September. It’s impossible to say for sure where the index will end the year, but many believe it still hasn’t bottomed, given the high valuations and macro environment. Admittedly, many investors are wondering if it’s safe to invest in the Nasdaq right now.
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Is it still overrated?
Whether or not it is safe to invest in the Nasdaq depends on your risk tolerance, goals, investment horizon, and other personal factors. But generally speaking, there are two pieces of information that can help you make this decision.
The former can help you determine if, in fact, we’ve hit rock bottom or if there’s still a long way to go. A key indicator that a bear market has bottomed out is the price-to-earnings (P/E) ratio. As my colleague Sean Williams wrote recently, bear markets in recent history have tended to end when the futures P/E of the S&P500 falls in the 13-14 range.
As of September 7, the S&P 500 P/E was 19.9. With a historical average of around 15.9, this would suggest that the P/E ratio is still above average at this time. The forward PER, which is based on earnings forecasts over the next 12 months, is around 17.5, which also suggests that the market could go down.
Another valuation measure is the Shiller P/E Ratio of the S&P 500. Also known as the Cyclically Adjusted PE Ratio (CAPE Ratio), it is based on average inflation-adjusted earnings for the previous 10 years. . Currently, the Shiller ratio is 29.5, well above the historical average of around 17.
Although these measures all refer to the S&P 500, not the Nasdaq, the S&P 500 is used because it is more representative of the overall market. The Nasdaq’s average P/E ratio will be slightly higher than the S&P 500, but keep an eye on the Nasdaq and S&P 500’s average P/E ratio as they return to historic levels.
The best long-term investment
The other important thing to know is that no major index has produced better long-term returns than the Nasdaq Composite or the Nasdaq 100 – which are the 100 largest non-financial stocks on the Nasdaq. Over the past 10 years, through September 6, the Nasdaq Composite has returned 14.1% annualized, while the S&P 500 has an annualized return of 10.7% and the Dow has an annualized return of 9 %.
If we go back 20 years, the Nasdaq has an annualized return of 11.7%, compared to 7.7% and 6.8% for the S&P 500 and the Dow, respectively. The Nasdaq 100 is even better with a 13.8% annualized return over 20 years through September 7.
A better parallel might be the market during the Great Recession. On October 1, 2008, the Nasdaq was down 22% year-to-date at around 2,075. From October to the end of 2008, it fell to 1,578 and ended the year down 40 %. If you had invested in the Nasdaq on October 1, not knowing that it would lose another 500 points, what kind of return would you have? Even with this decline, the index has posted a 13% annualized return since then, through September 6, 2022.
So to answer the question, “Is it safe to invest in the Nasdaq right now?” If you are already invested in a Nasdaq ETF, the answer is definitely yes. The bear market will eventually end and in the long run the Nasdaq has been one of the best investments there. Selling now would only lock in your losses.
If you’re considering a new investment in a Nasdaq-biased fund, you might want to wait until you start to see valuations drop a little more. But over the long term, the Nasdaq is a great investment.
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