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Flash info: equities can also fall.
Since the bear market low of March 2020, technology Nasdaq Composite (NASDAQINDEX: ^ IXIC) was virtually unstoppable. The growth-oriented index has more than doubled in value in less than 11 months. But since its peak on February 12, 2021, the Nasdaq has run into trouble.
On Monday March 8, the closely watched index fell to a close of 12,609. This marked its lowest close since December 15 and officially put the Nasdaq Composite in correction territory with a decline of 10 , 5%.
But what if this was just the start of a bigger drop, or maybe even a crash? At the moment, three catalysts suggest that the Nasdaq Composite could go from an ordinary fix to a full-fledged crash.
Image source: Getty Images.
1. Assessment
While the rapid rise in Treasury yields has been the main concern on Wall Street recently, valuations could be even more worrying.
According to enterprise data provider Siblis Research, the Nasdaq 100 – an index of the 100 largest non-financial companies listed on the Nasdaq change – end of 2020 with a 12-month price-to-earnings (P / E) ratio of 39.5 and a cycle-adjusted price-to-earnings ratio (CAPE) of 55.3. The CAPE ratio takes into account earnings adjusted for inflation over the previous 10 years. In a certain context, the Nasdaq 100 P / E ratio as of December 31, 2020 was practically double where it ended in 2018 (20.3), and the CAPE ratio is well above historical norms.
And it’s not just the Nasdaq 100 either. The CAPE ratio for the S&P 500 (SNPINDEX: ^ GSPC) stood at 35.3, as of Wednesday, March 10. That’s more than double its average reading of 16.79 over the past 150 years. There have only been five instances where the S&P 500’s CAPE ratio has exceeded and maintained 30. In each of the previous four cases, the benchmark has lost between 20% and 89% of its value.
Don’t worry, the 89% loss associated with the Great Depression is very unlikely to happen again. But a bear market has always been in the cards when valuations are pushed as much as we are seeing now.
Image source: Getty Images.
2. Coronavirus variants and vaccine adoption
In many ways, the news has been mostly positive on the coronavirus disease 2019 (COVID-19) front. Following emergency use approval from the Food and Drug Administration Johnson & johnsonthe COVID-19 vaccine, there are now three vaccine options for Americans. The United States has also administered at least one dose to over 19% of the American population.
And yet, the pace of vaccination may not be fast enough. The problem is that the SARS-CoV-2 virus that causes COVID-19 has mutated several times since the original virus was discovered. These mutations threaten to reduce the effectiveness of approved vaccines. Even if collective immunity were to be achieved in the United States, variations could develop outside the United States and be brought here unknowingly by travelers.
Additionally, it is not known whether a large enough percentage of the American adult population will choose to be vaccinated. A February survey from the Pew Research Center found that about 30% of respondents definitely or likely will not get the vaccine. While this means that 70% will eventually receive the vaccine, some researchers have suggested that a higher vaccination percentage would be required to achieve herd immunity.
In short, with the reopening or easing of restrictions by some states and the pandemic not yet in the mirror, there is a clear possibility of setbacks.
Image source: Getty Images.
3. Increased use of leverage among retail investors
A third reason for concern about the Nasdaq, and growth stocks in general, is the leverage used by retail investors.
According to a Harris poll from September 2020, 23% of retail investors surveyed had bought options, 10% had bought stocks on margin, and 10% had both bought options and bought stocks on margin. In fact, 43% of all retail investors used some form of leverage or speculation to try to time the market.
For almost 11 months, things went very well for these retail investors. But over the past month, leverage has been a curse. If stocks start to move in the wrong direction, it could lead to margin calls, i.e. cases where brokerage houses ask for additional funds from investors to maintain a certain level of liquidity relative to this. that they borrowed. Historically, most stock market crashes are exacerbated by the combination of short-term emotional trading and margin calls.
In other words, just as retail investors excited Wall Street with Reddit’s frenzy, they could be its near-term loss if a wave of margin calls were to hit.
Image source: Getty Images.
The best thing about crashes
Now keep in mind that just because the catalysts for a crash exist, doesn’t mean it’s imminent. An argument could have been made throughout the 2010s that a bear market was brewing. In the end, we got through the entire decade with nothing more than a few big corrections (losses of up to 19.9%) in the S&P 500.
However, if a Nasdaq Composite crash occurs, it would actually be a blessing in disguise. Crashes are historically short lived, emotionally motivated, and always an opportunity for long-term investors to put their money to work for big business. Finally, all the major US indices recover their losses following the crashes and the corrections.
For now, we’re patiently watching how growth stocks react to their first real challenge since March 2020. But it wouldn’t hurt to have some cash on hand in case one or more of the aforementioned catalysts do. materialize and the Nasdaq would plunge.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.
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