With the NASDAQ now in correction territory and spreading to global markets, is this the end of the COVID recovery?
After last night’s brutal fall of 4.11%, the NASDAQ is now down roughly 11% in three sessions and this has dragged the S&P 500 down 7% over the same period. Not surprisingly, the Aussie market has faced a couple of very rough sessions and is down 4% since the beginning of the NASDAQ’s falls. While those numbers look atrocious, the NASDAQ is trading back where it was in mid-August and is still up 58% from its lows in March.
So, what has driven the selling? Well, I think the very simple answer is nothing. The turn in the market was random, but after the run the market had it only takes a hint of selling to see a quick correction. There is talk of a huge options position by Japanese firm Softbank which may be the catalyst, but even without a catalyst a fall was due to come. Markets don’t go up in straight lines over the long term – although it did from March until now – so the easy explanation is to simply say that this is a return to a more logical and healthier place. While the tech-heavy NASDAQ has undoubtedly experienced pandemic tailwinds which have contributed to long-term earnings upgrades, the rally has easily exceeded the impact to earnings across the board and what we have seen is significant P/E (price to earnings) expansion.
I have argued regularly in recent months about my view that the changed outlook for long-term interest rates will play a larger role in the future direction of the market than the lingering impact from the pandemic. Assuming we do see an effective vaccine, economies will return to normal, but 10-year government bonds are all yielding less than 1%. This is unprecedented, and in my view will lead to higher P/E multiples for the market; especially for higher-growth, strong cash-generative businesses such as technology stocks or online retailers. So, what we have seen since Thursday night isn’t a fundamental change to the market environment in my view and just a healthy sell-off that will present more attractive entry points for a stock market that offers long-term returns above that of other asset classes. And to technology names specifically, the trends we have seen since the pandemic hit were already in their early stages and COVID has simply accelerated the trends.
I came across a very interesting stat which I think explains the big impact the internet has had on listed companies, and why the P/E premiums they currently command are appropriate and worthy of long-term expansion. Between 1984 and 2009, the S&P 500 produced free cash flow as a percentage of sales of 4.7%, but since 2009 this has doubled to 10%. In an environment that will reward long-term free cash flows because of the low discount rate used in asset valuation methodologies, that stat is a pretty telling explanation of why P/Es have grown in recent years and could continue to grow in the post-COVID world.
So, while sell-offs are always tough to digest it’s important to look at every sell-off in context. And despite the dizzying moves of the past few days, which very well may continue in the short-term, the overall long-term picture just hasn’t changed.
