NASDAQ: A Historical Perspective
The NASDAQ 100 Index reached all-time highs this week. While the Index briefly entered a bear market in March, it regained its losses by early June and continued its upward climb. Year-to-date through July 31, 2020, the NASDAQ outpaced the S&P 500 by roughly 2,300 bps, helping propel the NASDAQ’s strong performance over the past decade.
The NASDAQ’s recent outperformance has led market observers to draw parallels to the dot-com boom. The NASDAQ also significantly outperformed the S&P 500 during the 1990s, culminating in a March 2000 peak. In recent years, the NASDAQ has been driven by a narrow group of stocks, which have also contributed to divergence between large cap growth and value indices.
The larger Index components in both 2000 and 2020 were companies with defensible business models. However, of the top 10 holdings in March 2000, only Microsoft remained in the top 10 as of July 2020.
The drawdown from March 2000 highs took roughly 18 months, with the Index bottoming out in October 2002 with a decline of roughly 83%. While the top Index holdings sold off sharply during the dot-com bust, most survived the downturn yet took more than a decade to regain their market valuations. Second-tier NASDAQ stocks fared significantly worse; many were delisted or acquired at large discounts to their peak values.
The NASDAQ continued to lag the S&P 500 through 2006. While it outperformed the S&P 500 since the start of the global financial crisis in 2007, it took the Index until August 2016 to reach the March 2000 highs again.
As was the case in 2000, the Index is currently dominated by IT and IT-related stocks. As of July 31, 2020, IT was the largest sector in the NASDAQ (47%), followed by communications services (20%). Internet-related consumer discretionary stocks accounted for another 13% weight.
However, a notable difference is the concentration of the Index and of performance. As of July 31, 2020, the FAANGM constituents—Facebook, Apple, Amazon, Netflix, Google/Alphabet, and Microsoft—made up almost half (49%) of the Index. These six stocks also accounted for the majority of the NASDAQ’s performance in recent years and more than 100% of its performance for the trailing 10 years. The NASDAQ’s performance during the dot-com bubble was driven by a wider group of constituents.
While the valuations of the NASDAQ stocks are currently elevated relative to both the broad U.S. market and historical averages, they are not comparable to valuations that led to the sharp sell-off in the aftermath of the dot-com boom. This was true across a variety of metrics, including P/E, P/S, P/CF, and FCF Yield.
Multiple expansion, particularly in the year-to-date period, has been a meaningful driver of higher valuations and relative returns. For example, the NASDAQ’s price/equity ratio moved approximately 25% higher while free cash flow yield fell roughly 16% from year-end 2019 to July 2020. Many of these stocks are viewed as insulated from the swift changes in global consumer and corporate behavior caused by the COVID-19 pandemic, resulting in valuations that may have increased ahead of fundamentals.
While the NASDAQ peaked in early 2000 and more recently achieved new all-time highs, there are notable differences since then, as measured by valuation and the narrowness of market leadership. Driven in large part by the performance of the FAANGM stocks in recent years, Index valuations are currently elevated relative to history, yet well off levels realized in 2000. Given that the six largest Index constituents currently account for nearly half of the NASDAQ, we anticipate the success or challenges of these stocks in coming years will have a significant influence over future Index returns and valuations.