It's amazing how quickly sentiment can shift on Wall Street.
One year ago, on Feb. 19, 2020, the benchmark S&P 500 (SNPINDEX:^GSPC) hit what was then an all-time high. But in the wake of the coronavirus disease 2019 (COVID-19) pandemic, the broad-based index went on to lose 34% of its value over the following 33 calendar days. For some context here, previous bear market losses in the S&P 500 of at least 30% took an average of 11 months to occur. COVID-19 caused a 34% decline in merely a month.
Now, it's looking like the Nasdaq Composite (NASDAQINDEX:^IXIC) may share a similar fate one year later.
Is a Nasdaq Composite bear market brewing?
The Nasdaq Composite, which leans heavily on high-growth technology and biotech stocks, has widely outperformed the S&P 500 and the iconic Dow Jones Industrial Average since the bear market bottom on March 23, 2020. The Feb. 12, 2021 closing high of 14,095.47 represented a peak gain of almost 106% in less than 11 months.
The market cap-weighted index with a strong leaning on growth stocks has benefited from the rise of the work-from-home economy, as well as historically low lending rates. With the Federal Reserve pledging to keep rates at or near historic lows through 2023, fast-growing tech stocks should have easy access to cheap capital.
But even these immense catalysts may not be able to stop a Nasdaq bear market (i.e., a 20% or greater decline) from brewing. In just three weeks, the Nasdaq has shed 8.3% of its value, and was down a peak of 12% during its intraday low on March 5.
On a macro basis, rising Treasury bond yields have investors spooked. Even though it's perfectly normal to see yields rise during the early stages of an economic recovery as investors sell bonds and buy stocks, folks are worried that rapidly rising yields could cause an exodus in the other direction. In other words, Treasury bonds are viewed as highly safe, income-producing assets. If yields were to handily outpace the inflation rate, some investors might choose bonds over stocks.
The coronavirus pandemic also remains a front-and-center concern. Even with three COVID-19 vaccine options, the worry is that not enough people will choose to be vaccinated, which could delay herd immunity.
And then there's valuation, which might be the biggest concern of them all. According to enterprise data company Siblis Research, the Nasdaq 100 -- an index of the largest 100 non-financial companies on the Nasdaq Composite -- entered 2021 with a trailing price-to-earnings ratio of nearly 40 and a cyclically adjusted price-to-earnings (CAPE) ratio of 55! That's up from a CAPE ratio of 35 at the end of 2018. At some point, valuation always comes back into focus.
If a bear market or steep correction is brewing, it would not be a surprise if the growth stocks that led the Nasdaq Composite higher also led the charge lower.
Short-term pain can lead to long-term gain
Then again, if emotional selling does arise, count yourself lucky, because you'll be able to scoop up great companies at bargain prices.
For example, continued selling in cybersecurity solutions provider Okta (NASDAQ:OKTA) would provide an excellent opportunity for investors to buy into the leading provider of cloud-based identity verification. Okta's solutions are cloud-native and lean on artificial intelligence to grow smarter over time. Being built in the cloud allows Okta to be nimbler at identifying and responding to potential threats.
What's more, Okta agreed to acquire privately held Auth0 this past week in an all-stock deal worth $6.5 billion (at the time of the announcement). Auth0 is also a cloud-native platform that'll be operated as an independent unit under the Okta umbrella. More importantly, it should generate north of $200 million in sales this year and provide increased exposure outside the United States. A decline in Okta is an absolute gift for long-term investors.
A Nasdaq Composite bear market would also allow investors who missed the initial rocket launch of teleconferencing platform Zoon Video Communications (NASDAQ:ZM) a second chance to jump onboard. Last week, Zoom reported full-year sales of $2.65 billion (up 326% from 2019), which is up from a midpoint of $910 million in sales that was expected when 2020 began. As you can plainly see, Zoom was a key beneficiary of the COVID-19 pandemic.
The thing is, Zoom should remain in play well after the pandemic has passed. As of April 2020, Zoom controlled 42.8% of all web conferencing technology in the U.S., which was more than double its next-closest competitor. Though some workers will soon be heading back into the office, the luxuries of working from home aren't going away. Zoom is the type of business that could triple its sales by mid-decade.
Things are definitely dicey at the moment for high-growth tech stocks, and they could get worse for the Nasdaq's most prominent highfliers. But if your investing horizon stretches out many years, you have little to worry about.