The NASDAQ-100 Index has consistently demonstrated outstanding performance since its inception in 1985, with a cumulative increase of 2,290% to date (including reinvestment of dividends), and an annual compound total return rate of 14.8%. In comparison, the S&P 500 Index has seen a return of 720% over the same period (including reinvestment of dividends), with an annual compound total return rate of 11.5%.
However, the leading performance of the NASDAQ Index can be partially attributed to its assumption of higher risk. The index has always exhibited higher volatility than the S&P 500 Index, and its drawdowns are also significantly larger. The NASDAQ Index entered a downtrend starting from March 28, 2000, and by August 5, 2002, it had plummeted by -81.76%. It was not until February 12, 2015, that the NASDAQ-100 Total Return Index recovered to its previous peak. During the 2022 bear market, the index also experienced a more severe decline.
Dependence on Information Technology
Contributes to High Returns and High Volatility of the NASDAQ Index
The NASDAQ Index's reliance on the information technology sector has largely contributed to its higher overall returns, greater volatility, and increased susceptibility to long-term, deep drawdowns. As early as the 1990s, the NASDAQ almost became synonymous with the technology industry.
Although almost every industry is represented in the NASDAQ Index, since its launch in 1999, the NASDAQ-100 Index has maintained an almost perfect correlation with the S&P 500 Information Technology Index. The correlation coefficient between the two has never been below +0.9, and at times has reached as high as +0.98. Over the past 12 months, this correlation coefficient has remained around +0.95.The Nasdaq's status as a stronghold for technology stocks is largely a result of historical development. Established in 1971, the Nasdaq was the world's first electronic stock exchange, and its more flexible requirements for listed companies' revenue and profitability compared to other exchanges made it popular with tech firms from the outset. Over time, the tech ecosystem has essentially taken root in the Nasdaq securities market and gradually come to dominate the Nasdaq 100 Index.
For investors who need to control tracking risk associated with the S&P 500 Information Technology Index, utilizing the S&P Select Technology Sector Index futures can achieve this goal. For those who wish to increase or decrease their exposure to the technology sector overall, and for investors who are less concerned about tracking risk, the Nasdaq 100 Index futures can easily adjust their positions.
In recent years, the Nasdaq Index has also shown a high correlation with the non-essential consumer goods and telecommunications sectors. In contrast, the index tends to have a lower correlation with traditional high-dividend sectors (such as essential consumer goods, energy, and utilities), as companies in these industries often prefer to list on other exchanges. The only exception to this pattern occurs during market downturns, when correlations among various stocks tend to rise.
The Nasdaq Index is not sensitive to long-term bond yields, but currently faces four major risks.
The interest rate sensitivity of the Nasdaq Index also differs significantly from other indices. Firstly, because many companies in the Nasdaq 100 Index have substantial cash reserves, they can earn high returns by holding U.S. Treasury bills and other short-term bonds, so high short-term interest rates seem to be more beneficial for Nasdaq 100 companies. This is in stark contrast to the Russell 2000 Index, which has suffered due to the Federal Reserve's consecutive interest rate hikes increasing the financing costs for small and medium-sized enterprises (these businesses mainly rely on bank loans and find it difficult to finance through bond issuance, and they typically do not have substantial cash reserves).
In contrast, facing rising long-term bond yields, the Nasdaq Index has shown a high negative sensitivity. Many tech stocks in the Nasdaq 100 Index have high price-to-earnings ratios. There are even giants with market values exceeding one trillion U.S. dollars. A significant portion of these companies' value comes from what stock analysts call "perpetual value" (the value that can be reasonably predicted beyond the forecast period), and their profits are typically discounted according to long-term bond yields. Therefore, the higher the yield, the lower the net present value of future profits, so a rise in long-term bond yields poses a potential threat to their stock prices. Additionally, higher long-term bond yields may also attract investors to sell off volatile and more expensive stock portfolios and turn to relatively less volatile fixed-income securities.
In 2022, due to market expectations of the Federal Reserve's tightening policies and concerns about persistent inflation, the yield on U.S. long-term Treasury bonds rose, causing prices to plummet sharply, and the Nasdaq Index also suffered a significant decline. The reason for this phenomenon may be explained by the index's high sensitivity to long-term bond yields. In contrast, although from October 2022 to July 2023, the Federal Reserve consecutively raised short-term interest rates and then kept short-term rates high, the Nasdaq Index performed well. On the one hand, this was because many Nasdaq companies with ample cash benefited from holding short-term bonds. On the other hand, raising short-term interest rates reflected the Federal Reserve's emphasis on the inflation issue, which helped stabilize long-term bond yields and thus also benefited these companies.
This is not to say that the Nasdaq Index is immune to the risk of decline. Historical experience shows that risks do exist, especially during economic recessions. During the economic recession triggered by the 2001 tech stock crash, the Federal Reserve reduced short-term interest rates from 6.5% to 1%, but long-term bond yields remained relatively high, which was not helpful for the tech sector. In addition to plummeting 82% during the tech stock crash, the Nasdaq 100 Index also fell sharply when the global financial crisis broke out, although not as dramatically as the S&P 500 Index, which had a higher weight of bank stocks.
Currently, the potential threats facing the Nasdaq Index include: the threat of economic recession—which could erode corporate profits; interest rate cuts—which could reduce the return on cash holdings; large budget deficits and quantitative tightening policies—which could drive up long-term bond yields; and the possibility that the United States and other countries may strengthen regulation of the technology industry.