After plunging in 2022, the Nasdaq has come back in a big way this year. Through July 11, the tech-heavy index is up 31% for 2023, easily outpacing both the S&P 500 and Dow Jones Industrial Average.
The Nasdaq has surged as many of the biggest tech stocks entered the year at unusually low valuations after falling during the bear market in 2022. And excitement around artificial intelligence (AI) has also supercharged the tech sector as investors are angling for a piece of what many think will be the next transformative technology.
But after the tech-centric index has already rallied so far this year, is it still safe to invest in the Nasdaq? Let's consider a few things before making a big buy.
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Valuations are getting stretched
The stock market is forward looking, which means that prices move before fundamentals do. And that truism has been evident this year as stock prices have soared on anticipation of a recovery and an AI boom that has yet to fully materialize. That has led to rapidly expanding valuations, as the chart below helps illustrate.
Data by YCharts.
As you can see, this cohort of major tech stocks have seen their valuations balloon significantly from the start of the year, and some of them now have price-to-earnings (P/E) ratios hovering at multi-year highs.
Stocks like Microsoft and Alphabet have soared as they've made big bets on AI. Meta Platforms has gained as it's responded to investor demands to control costs and as the core social media business is seeing momentum in areas like Reels.
Lastly, Apple has gained due in part to the launch of its new Vision Pro headset, and it continues to gain market share with products like the iPhone.
But Nvidia might offer the best example of investor bullishness in 2023 as the stock soared back in May after it gave breakout guidance for the second quarter due to demand for AI chips, even though it actually reported a decline in revenue in the first quarter.
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Data by YCharts.
As you can see, Nvidia's valuation has absolutely exploded this year, reaching levels not seen in two decades.
The Nasdaq 100, which is made up of the 100 largest stocks in the Nasdaq Composite, now has a P/E of 31.2, which is higher than it was a year ago at 25.2. It's also significantly higher than the S&P 500 at 19.7 and the Dow at 22.7. The S&P 500's P/E is actually down from a year ago, while the Dow's P/E has risen.
The best way to play the Nasdaq
The rising valuations shouldn't scare you away from the Nasdaq entirely. Those seem to be a reflection of signs that the worst has passed in the tech recession, with a number of big tech companies reporting accelerating revenue growth in the first quarter.
But with stocks like Apple and Microsoft already testing all-time highs, it makes more sense for investors to look for stocks that have yet to recover most of their losses.
This includes names like Roku and Upstart, which have already experienced significant gains this year but are still down more than 80% from their earlier peaks.
Roku has been hit hard by the slowdown in digital advertising, but the stock should bounce back as that industry recovers. Meanwhile, Upstart, which uses AI to measure creditworthiness for its lending platform, should benefit from an improving economy and a more stable credit and interest-rate environment.
Keep an eye on quarterly numbers from big tech companies and other stocks you may be watching. If top-line growth continues to show momentum, the Nasdaq could be well on its way to a new bull market.
