Flight to Quality: NASDAQ 100 Has Its Worst Start to a Year Since 2000

It started in late 2021, and is now spilling over into the new year. No, I’m not referring to Omicron, though the problem that’s currently endemic to the equities markets could indeed spread like a virus.

I’ve heard market commentators refer to the “great rotation,” but there are really multiple rotations going on. One of them is an exodus from small caps into large caps, which has been in progress for a while but is particularly pronounced in early 2022.

Moreover, this type of rotation isn’t new, and it will correct itself at some point. It’s actually not a terrible idea to add a handful of small-cap companies to your portfolio at a time like this, as they could play catch-up this year and outperform their large-cap counterparts.

Yet, the most notable rotation isn’t between the Russell 2000 and the S&P 500. Rather, it’s between “momo” or momentum stocks – which for the past 12 or 13 years, have typically been technology stocks – and the value stocks which your father and grandfather may have held on to for decades.

This is problematic as a handful of tech-focused names dominate the market-cap-weighted S&P 500 and NASDAQ 100, the latter of which recently declined seven out of eight days and had its worst start to a year since the year 2000.

Courtesy: ZeroHedge

The main culprits here are the FAAMG+T stocks. These are Facebook (a.k.a. Meta), Apple, Amazon, Microsoft, and Google (a.k.a. Alphabet), plus Tesla of course. Amazingly, just those six stocks represent around 25% of the S&P 500’s market cap.

Why is this happening? Supply-chain issues are part of the problem, as it’s becoming more difficult for companies like Microsoft and Apple to get the microprocessors and other components that they need.

Omicron might also figure somewhere in the equation, but that’s not the primary driver of the tech wreck. If we’re going to blame anybody, it should be the folks at the Federal Reserve, who allowed inflation to “run hot” and are now practically forced to raise government bond yields at some point.

They’re also expected to reduce the pace of the Fed’s monthly asset purchases, which helped to shore up the stock market in 2020, when the Covid-19 pandemic gave the Fed a perfect excuse to flood the banking system with liquidity.

That program of buying massive quantities of bonds and mortgage-backed securities wasn’t supposed to last forever, and it’s already overstayed its welcome. The Fed had to act surprised when a 6.8% annualized inflation rate print came out, but this is what happens when you crank the money printer up to 11 and leave it there.

Courtesy: ZeroHedge

The threat of a more hawkish Federal Reserve is causing a taper tantrum, even though the Fed hasn’t actually changed its monetary policy yet. It just goes to show how fragile this market is: even the hint of a less accommodate Fed is enough to make today’s investors jittery.

With the Santa Claus rally fully erased now, it’s a great time for informed investors to re-evaluate their strategies. Think about it: if the mere hint of an interest-rate hike is enough to cause a rotation out of expensive tech stocks, how much havoc would actual Fed action cause?

Call it a flight to “value” or “quality” if you’d like, but what’s happening in the markets now is sensible and healthy. We can only hope that the legions of young traders who only learned about stocks while stuck at home during Covid-19 lockdowns, will begin learning about P/E ratios, the Buffett Indicator, and other essential metrics.

Okay, so that’s probably not going to happen – and we can’t control what other people do, but we can modify our own strategies and brush up on the basics: are we buying stocks that represent solid, profitable businesses trading at a fair price?

Or, are we exposed to speculative stocks with a high degree of interest-rate sensitivity? At the end of the day, it’s not about inflation hedging anymore; it’s about hedging against a central bank that didn’t think about tomorrow yesterday, and the you-know-what is hitting the fan today.