Nasdaq 100 analysis: Valuations look lofty as it hits 14-month high

Tech drives Nasdaq 100 to 14-month highs

The Nasdaq 100 closed at a fresh 14-month high for the fourth consecutive session yesterday as investors continue to flock to technology stocks and the mania around artificial intelligence continues to rip through Wall Street.

Microsoft, Apple, Broadcom and NVIDIA – which collectively make up 34.6% of the index – are all trading at record highs.

Meta and Alphabet – which make up another 11.8% of the Nasdaq 100 - still have a long way to go before they are anywhere near the record highs we saw in 2021 as we are still waiting for a recovery in the advertising market, but both are on the right path. The social media giant is at a 16-month high while the Google owner is not far off recent 14-month highs.

Tesla, which has a 4.2% weighting in the index, celebrated a record-breaking winning streak after closing up for 13 consecutive sessions and climbing to eight month highs. The rally, caused by Tesla stirring excitement about the value of its charging network after convincing Ford and General Motors to adopt its connector and utilise its Supercharger network, added some $240 billion to Tesla’s market cap – the equivalent of adding the same value whole of Toyota in less than two weeks. The move higher has stalled but shares have quickly rebounded again.

Elsewhere, other stocks carrying a significant weight in the index are also pushing higher. Software giant Adobe (1.5%) has popped to a 16-month high today after impressing the markets yesterday and getting investors excited about its AI prospects following the recent rollout of new products. Intel (1%) is at 10-month highs after reports suggested it could invest in the eagerly-awaited IPO of semiconductor giant Arm. And Netflix (1.3%) is at 16-month highs as it continues to recover those heavy losses we saw last year thanks to hope its new ad-supported tier and crackdown on password sharing will revive growth this year.

Nasdaq 100 analysis: Most overbought stocks

Most of the stocks that have climbed to fresh highs are now in overbought territory based on the Relative Strength Index (RSI). A RSI reading of over 70 indicates a stock could be overbought, signalling that a pullback could be on the way. The Nasdaq 100 as a whole is overbought on this basis, with Tesla, Netflix, Adobe and Broadcom atop the list.

We have also added each stock’s blended forward price-to-earnings ratio as this highlights the lofty valuations in the tech space at the moment. This is partly because markets are already attributing huge value to the prospects around AI within just a few months of the technology grabbing the world’s imagination. Investors may be keen to jump on the AI bandwagon, but you should always consider whether the price of admission is too high. Even those not caught up in the AI whirlwind are looking pricey. Tesla, NVIDIA, Zscaler, Palo Alto Networks and Intuitive Surgical all look particularly expensive right now on this metric.

(Source: BF PE ratios from Blomberg, as of June 16, 2023)

Are Nasdaq 100 stocks overvalued?

The Nasdaq 100 has outperformed the market thanks to the high level of technology stocks within the index, having risen almost 40% since the start of the year compared to the 15% rise in the S&P 500. The Dow Jones Industrial Average, which has much less tech exposure, is up a tepid 3.8% this year.

Tech stocks have demanded a premium over the wider market for some time because they have boasted better growth prospects, prompting investors to attribute more value to future earnings and cashflow. However, this premium is much wider than the usual. The Nasdaq 100’s PE ratio is at a 30% premium to what we have seen on average over the past decade!

AI is now fuelling those valuations being applied to growth. Just look at NVIDIA. The chipmaker has managed to triple its valuation and boost it by over a staggering $600 billion since the start of 2023. It appears a solid bet that AI will boost its sales this year and in the future, but how many years of this additional growth has already been priced-in?! We could see some of the value attributed to AI unwind as hype dies down and these valuations are tested in forthcoming earnings seasons.

It isn’t all just AI though. The largest players in the space, like Apple and Microsoft, have also reaped rewards from the enthusiasm for AI but they have also remained attractive to investors because they have what it takes to deliver whatever the environment. They can deliver reliable cashflows and earnings during a downturn and have almighty cash balances to draw upon in tougher times, and are set to be among the biggest beneficiaries when conditions improve again. While the likes of Apple and Microsoft boast a premium, they are at much lower levels than we are seeing elsewhere in the tech space and these are potentially more justified in the current environment, and this may also make the likes of Alphabet and Meta – both trading at much lower multiples – more attractive.

Where next for the Nasdaq 100?

The Nasdaq 100 has now closed at fresh 14-month highs for four consecutive sessions. The index is on course to make it five considering it is up another 0.1% in early premarket trade today.

All three moving averages continue to trend higher and the index remains on course to hit 15,300, which would mark a 78.6% retracement from the lows we saw last October, if it can keep up the momentum. A sustained move above here would provide a fresh bullish sign.

However, the rally has pushed the RSI deeper into overbought territory. Any pullback would likely lead to a fall back toward at least 14,560 while a sharper reversal could send it back toward the 61.8% retracement and see it slip below 14,300.