This article is written exclusively for Investing.com
It has fallen sharply to begin 2022, down nearly 13%. But don't expect the index to race back to record highs anytime soon. The index faces a battle on two fronts, higher rates and falling earnings estimates. That means the NASDAQ may struggle to gain a foothold for the next six months. fell to $478.43 per share for 2022, down 5.5% from a peak of $505.83 on August 25. The drop in earnings expectations is notable as rising real returns will lower the index's PE ratio. Combined, lower PE and falling earnings estimates will limit potential gains for the index. saw its PE ratio return to its December high of 33.1, the index's value would rise to just 15,835. That would be close to November's intraday high of 16,212, but still close to 2.5% lower. That means it will take an even higher PE ratio to top the previous highs for the NASDAQ.
That can be difficult as real yields are soaring, which will work to push the NASDAQ earnings yield higher and the PE ratio lower. The 5-year TIP rate rose sharply in 2022, rising to about -1.05% from about -1.64% on December 31. In the same time, the earnings yield for the NASDAQ Composite has risen to 3.49. % of 3.06%, based on EPS estimates for 2022. Essentially, the more real revenue increases, the more likely it is that NASDAQ earnings revenue will also increase.
The earnings yield is the inverse of the PE ratio, so as the earnings yield increases, the PE ratio decreases. The problem is that 5-year real yields are breaking out, and if the Fed remains as aggressive as it appears, the breakout could cause the 5-year TIP to rise to about -50 bps.
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That would drive the NASDAQ's earnings yield even higher, possibly by another 60 basis points to about 4%. That would equate to a PE ratio of 25. Given its earnings estimates of $478.43 for 2022, it would value the NASDAQ Composite at 11,960, down another 13%.
However, this all depends on how far the real yields increase. But the Fed is expected to start raising interest rates in March. Significant market declines are likely to occur over the next six months as the stock market re-prices for tighter monetary policy and higher interest rates. this process than others. Especially those stocks that have seen more substantial earnings growth and have more manageable valuations. For example, a stock like Meta Platforms (NASDAQ:) has risen dramatically over the past two years, but it has also seen a strong rise. profit growth. The stock is trading on a historic basis at just 21 times earnings expectations for the next 12 months. While the stock can easily fall during a broader market decline, the lower valuation could provide a level where investors see value in Meta, which supports the stock. On the other hand, stocks like Shopify (NYSE:) may still have a more challenging time. The stock has already fallen sharply, yet the stock is trading at 15.6 times sales estimates for the next 12 months, while historically it tends to trade between 9 and 12 times sales. This suggests there could be further downsides to the stock during a broader market sell-off.
If interest rates rise from here, and the stock market's success follows lower interest rates, it seems only natural for the market to readjust and adapt to these changes. This means there is the potential for earnings to weaken so that valuations finally matter again.
