The recent surge in the stock market, driven by the likes of mega-cap tech companies, has raised concerns about the potential formation of another bubble. The Nasdaq Composite index has been outperforming the S&P 500, leading some to believe that a bubble may be forming.
However, Jessica Rabe, co-founder of DataTrek Research, provides a different perspective on this trend. In a recent note, she argues that the Nasdaq may actually just be catching up to the larger-cap U.S. benchmark. Rabe also cautions against forgetting how dismal 2022 was for stocks, urging investors to consider the larger context.
So far this year, the Nasdaq has surged by an impressive 37.2%, while the S&P 500 has seen an 18.9% rally. However, over the last three years, the S&P 500 has outpaced the Nasdaq with a 42% rise compared to a 37% increase for the tech-heavy index.
To provide a more comprehensive view, DataTrek ran a historical analysis of the three-year rolling returns for both the S&P 500 and the Nasdaq Composite over the past 50 years. This approach helps smooth out year-to-year seasonality and volatility while capturing a wide range of business, interest rate, and valuation cycles.
According to Rabe’s analysis, the Nasdaq Composite tends to outperform the S&P 500 over a three-year time horizon while also displaying higher volatility, as one would expect. Since 1974, the average three-year price return for the Nasdaq has been 41%, compared to 29% for the S&P 500.
With that in mind, this year’s performance can be seen as a reversion to the longer-term mean. As we continue to monitor the market, it is important to consider the historical context and broader trends at play.
The Nasdaq’s Catch-Up Game in 2023
The Nasdaq has lagged behind the S&P by about 500 basis points in the past three years, a significant difference considering the Comp typically outperforms by a much larger margin (+1,220 bps). However, analysts predict that the Nasdaq is poised to make up for lost ground this year.
Consistent Positive Returns
Historical data reveals that three-year returns for both the Nasdaq and S&P tend to remain positive, with rare occurrences of negative returns. Additionally, these returns tend to trade within similar bands as previous cycles. Barring any major geopolitical or economic shocks, it is expected that both indexes will continue to generate positive double-digit returns over three-year periods.
Current Performance and Historical Context
Despite the double-digit rallies witnessed in the Nasdaq and S&P this year, their three-year returns are relatively ordinary compared to historical norms. Rabe, an expert in the field, notes that the Composite’s 37.1% return falls slightly below the average of 41.2%. However, it remains well within one standard deviation to the downside. On the other hand, the S&P 500 boasts a 42% rise over the same stretch, surpassing its average of 29%. It also falls within the standard deviation to the upside.
Reversion to Historical Averages
One significant factor contributing to these impressive rallies is a reversion to historical averages. Rabe highlights that the performances of the S&P 500 and Nasdaq in 2022 were on par with or just as poor as those witnessed during significant events such as the oil crisis and recession of 1973-74, the burst of the dot-com bubble, the lead-up to the second Gulf War, and the financial crisis of 2007-09. In this context, this year’s gains bring them closer to their three-year average returns without reaching bubble territory.
In conclusion, while stock valuations remain high, companies must continue to deliver on earnings. However, it is crucial to acknowledge that the recent rallies in both the S&P 500 and Nasdaq can be attributed to a reversion to historical averages rather than a bubble.