2023 is still young, but the Nasdaq is already off to a hot start.
The tech-centric index is up 9% through Jan. 23, outperforming both the S&P 500 and the Dow Jones Industrial Average.
However, that gain only represents a fraction of the Nasdaq's losses last year, as the index fell 33% due to rising interest rates, fears of a recession, and a contraction following outsize gains earlier in the pandemic.
After tech investors got burned last year, is it safe to invest in the Nasdaq now?
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What makes the Nasdaq different?
Since it's primarily focused on tech stocks, the Nasdaq tends to be more volatile than the S&P 500 or the Dow Jones Industrial Average. That's because tech stocks generally trade at higher valuations than the average stock, and the index doesn't include the kind of recession-proof sectors that can add stability like consumer staples, healthcare, or utilities.
Given their higher valuations, tech stocks are more sensitive to interest rates, which partly explains why the Nasdaq performed so poorly last year because rising interest rates made them less valuable.
While the Nasdaq is more volatile than the other major indexes, it has also historically outperformed them, making up for the losses in bear markets with larger gains in bull markets.
The current bear market has lasted over a year now, which bodes well for a comeback in the Nasdaq.
Additionally, many of the biggest tech stocks get most of their revenue from outside of the U.S., and the dollar has weakened significantly over the last few months, which makes international revenue more valuable.
What 2023 holds
Stocks have gotten off to a good start to begin 2023 because economic data has persuaded investors that inflation is steadily coming down, the economy can withstand higher interest rates, and the Federal Reserve will soon stop raising rates.
The jobs report in December showed the unemployment rate remains low at 3.5%, but wage growth slowed in line with the Federal Reserve's goals, and year-over-year gains in the Consumer Price Index for December also slowed to 6.5%, the slowest rate of gain since October 2021. The Wall Street Journal also reported that the Federal Reserve was likely to raise interest rates by just a quarter percentage point at its meeting next week, moderating the pace of rate hikes for the second time in a row, another bullish sign for stocks.
Though most economists are still expecting a recession, and S&P 500 earnings are forecast to decline in the fourth quarter, the stock market is a leading indicator, and much of that negativity could already be priced in. After all, the Nasdaq is still down nearly 30% from its peak in late 2021, suggesting room for recovery, and that many of the stocks in the index are oversold.
Is it safe to invest in the Nasdaq now?
Investors eyeing the Nasdaq have a choice. They can either invest in the index through an ETF or pick individual stocks. An ETF helps make investing easy by giving investors exposure to dozens of companies with just a single investment. However, if you're particularly confident in a few Nasdaq stocks, you're probably better off investing in those rather than an ETF.
No one can time the market, and it's impossible to predict how the Nasdaq will perform this year, but the risk/reward trade-off in investing in the tech-heavy index looks favorable now. Many top tech stocks have fallen substantially and trade at discounted valuations. Alphabet, for example, is trading at a discount to the S&P 500, as is Meta Platforms, and Apple is only slightly more expensive than the S&P 500.
In other words, investors can buy the FAANG stocks, or the group of top tech stocks that have mostly outperformed the S&P 500 in recent years, at a similar earnings multiple to that of the entire S&P 500.
That seems like a great opportunity for Nasdaq investors. Though these stocks could fall further this year, over the long run, investors are likely to benefit from today's discounted prices, especially once the next bull market starts.
