The Nasdaq selloff in the last several days represents a reset of valuation multiples to lower more sustainable levels. Consider the chart below of the Nasdaq Composite, the index mostly represented by growth and technology companies. The Green Line represents 2021 earnings (or profit) expectations for companies in the Nasdaq (per Bloomberg). The white line represents the Nasdaq price. As you can see, Earnings Estimates (Green line) have increased over 10% since the start of the year while the Nasdaq is close to flat on the year. As a result, valuations of companies in the Nasdaq are now about 10% cheaper to own now than they were at the start of the year.
Chart 1: Nasdaq Composite: Index Earnings Estimates for 2021 (Green Line) vs. Price (White line)
While there could be continued volatility as the market is still trading above a historical average, we believe green shoots are emerging.
- Company management teams have resumed providing guidance of forward expectations – this suggests improved visibility on the numbers management teams believe they can execute on (see chart below tracking guidance in the S&P 500).
- Certain companies are beginning to show signs of strength after short term drops in stock price. Consider Peloton, a company we like and believe has strong long term growth prospects bringing fitness and wellbeing into the homes of Americans and increasingly internationally as well. The Company suffered in the first part of 2021 from a correction to it’s expensive technology valuation (as mentioned above) as well as a company-specific treadmill recall. Upon providing investors with clarity on the recall and some color to potential bike sales next year, the stock is now up over 10% in the last week despite the Nasdaq selling off further in that time.
- Inflation and shortages. This is probably the hardest area to handicap – however we believe companies in industries benefiting from price increases are capitalizing on these. For example, Weyerhaeuser, one of the nation’s largest lumber producers, most recently reported profits that approximately doubled versus the prior year period driven largely by an increase in price, not volumes sold. The increase in price wasn’t driven by extreme shortages, which suggests pricing could smooth out in coming periods as trends normalize post pandemic.
We remain optimistic on the upside in the markets from here over the next 12 to 18 months as the factors above subside. We have been holding some cash and other safer securities in accounts to put to work in corrections. Once valuation multiples stabilize we expect to deploy this cash into companies we believe can execute on substantial long term market opportunities now at lower prices.
Chart 2: Management Teams in the S&P 500 have Resumed Guidance
Source: BofA Research