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Rational Exuberance: An Update On Nasdaq Valuations

By David BassaneseMarket OverviewJun 21, 2017 12:43
au.investing.com/analysis/rational-exuberance:-an-update-on-nasdaq-valuations-200195865
Rational Exuberance: An Update On Nasdaq Valuations
By David Bassanese   |  Jun 21, 2017 12:43
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Originally published by BetaShares

US technology stocks have corrected somewhat in recent weeks as concerns mount over possible overvaluation in the sector. This note suggests, however, that the strong performance of the Nasdaq 100 in recent times has continued to reflect solid underlying earnings growth, and that valuations remain far from stretched.

Nasdaq stumbles

As seen in the chart below, the Nasdaq has corrected back in recent weeks after posting strong gains since the election of US President Donald Trump late last year. The apparent catalysts for the latest move were concerns by some analysts that valuations were getting rich and that US market gains seemed increasingly narrowly based around the tech giants such as Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOG) (previously Google (NASDAQ:GOOGL)), Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB).

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Past performance is not an indicator of future performance

That said, from a purely technical perspective, a pull back in the market in any case seemed overdue. As evident in the chart above, even with the solid uptrend in this Index in recent years, pullbacks are common once short-run overbought conditions emerge (technically, for example, when the RSI index hits 70 or more) – as has also become evident in recent weeks. So far at least, prices have only dropped to their 50-day moving average, and volatility in the Index suggests prices could drop somewhat more – potentially back to the 200-day moving average – before the correction is complete.

Valuations still not overly stretched

Back in June 2015, I assessed valuations for the Nasdaq 100 as it surpassed previous record highs. At the time, I concluded that despite the market’s solid gains since the financial crisis, “valuations do not appear stretched”, as due to ongoing solid growth in underlying earnings, the Nasdaq 100’s price-to-forward earnings ratio was still a little below its longer-run average.

Fast forward two years, and the picture remains similar. Indeed, despite the Index’s solid gains in recent years, this has been largely matched by growth in forward earnings – such that the forward PE ratio up until this year had barely changed. In 2017, so far, however, price gains have exceeded gains in earnings – such that the forward PE ratio has increased from around 18 to 20 by end-May. Note, however, that this remains below the market’s long-run average (since the mid-1990s) of 27.4. Even stripping out the “bubble” years of inflated PE valuations between 1998 to 2000, the average PE drops to 24 over this period. In other words, even today, the Nasdaq 100's PE valuation is below its long-run average, despite the still historically low level of bond yields.

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Note: relative to long-run average levels, moreover, the S&P 500 Index is more expensively priced than the NASDAQ-100 – at end-May, the S&P 500’s forward PE ratio was 17.7, compared with an average since the mid-1990s of 16.2.

If you can’t beat’em…

Particularly in the case of Australian investors, having some exposure to the world’s leading tech companies – as the Nasdaq 100 Index provides – can help provide useful diversification within one’s investment portfolio. After all, the Australian market’s weighting to technology shares is very low (less than 2% market capitalisation), and leading US tech companies such as Apple, Alphabet, Facebook and Amazon are continuing to wreak havoc across Australia’s consumer sector – from media to retail.

Indeed, Amazon’s recent $US13.7 billion purchase of US grocery chain Whole Foods (NASDAQ:WFM) saw the share prices of leading local grocery chains such as Woolworths (AX:WOW), Wesfarmers (AX:WES) (owner of Coles) and Metcash (AX:MTS) (owner of IGA) sold down. Whether or not Amazon is capable of successfully winning market share in the already fiercely contested local grocery sector remains to be seen – but either way, the intensification of competition could place further downward pressure on profit margins within the sector.

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Rational Exuberance: An Update On Nasdaq Valuations
 

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Rational Exuberance: An Update On Nasdaq Valuations

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