No sector has been hit harder in this bear market than technology -- and technology stocks, by far, make up the bulk of the Nasdaq Composite index. It should come as no surprise then that the Nasdaq is down about 25% year to date, and the benchmark index has been in a bear market for most of 2022.
After the Nasdaq bounced back in July, gaining 12.4%, it fell back again in August, down 4.6%, and it has been heading south thus far in September. It is impossible to say with any certainty where the index will end the year, but many believe it still hasn't hit bottom, given the high valuations and the macroeconomic environment. Certainly, many investors are wondering if it's safe to invest in the Nasdaq right now.
Is it still overvalued?
The question of 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 may help you make that decision.
The first may help you determine if, in fact, we have reached the bottom or still have a 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 forward P/E of the S&P 500 falls to the 13-14 range.
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As of Sept. 7, the P/E of the S&P 500 is 19.9. With the historical mean at roughly 15.9, that would suggest the P/E ratio is still above average right now. The forward P/E, which is based on earnings expectations over the next 12 months, is roughly 17.5, which would also suggest the market could go lower.
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 the average inflation-adjusted earnings from the previous 10 years. Currently, the Shiller ratio is 29.5, much higher than the historical mean of roughly 17.
While these metrics all refer to the S&P 500, not the Nasdaq, the S&P 500 is used because it's more representative of the overall market. The average P/E ratio for the Nasdaq will run slightly higher than that of the S&P 500, but keep an eye on the average P/E ratio of both the Nasdaq and the S&P 500 for when they come back to historical 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 is the 100 largest non-financial stocks within the Nasdaq. Over the last 10 years, through Sept. 6, the Nasdaq Composite has returned 14.1% on an annualized basis, 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 Dow, respectively. The Nasdaq 100 is even better with a 13.8% 20-year annualized return through Sept. 7.
A better parallel might be the market during the Great Recession. On Oct. 1, 2008, the Nasdaq was down 22% year to date at around 2,075. From October through the end of 2008, it dropped all the way down to 1,578 and finished the year down 40%. If you'd invested in the Nasdaq on Oct. 1, not knowing it would drop another 500 points, what kind of return would you have? Even with that decline, the index has posted a 13% annualized return since then, through Sept. 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 certainly yes. The bear market will eventually end and long term, the Nasdaq has been one of the best investments out there. Selling now would only lock in your losses.
If you are considering a new investment in a Nasdaq-oriented fund, you may want to hold off until you start to see valuations come down a little more. But over the long term, the Nasdaq is a great investment.
