TThe Nasdaq Composite Index has experienced extreme weakness in the first trading days of 2024. The selloff is the worst since October 2022.
The market is sold out for several reasons. Government bond yields are rising. The yield on 10-year government bonds fell to as low as 3.88% at the end of 2023. On Friday, the yield jumped well over 4% following the stronger-than-expected employment report. Other factors contributing to market weakness include pressure on Apple, the company with the largest market capitalization in the market. Investors are concerned about exposure to China.
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The Nasdaq Composite is weighted by market capitalization. Stock price movements of the largest stocks have a greater impact on the index. Apple has a weighting of 12%, Microsoft has a weighting of 11%, Amazon has a weighting of 6% and Nvidia follows with 5%. For simplicity, it is fair to say that the big four also apply to the composite index.
Big tech companies and the Nasdaq composite performed exceptionally well in 2023. The index rose 43%. Apple increased by 46%, Microsoft by over 60% and Nvidia by a whopping 246%. Profit-taking becomes irresistible for many, but no one likes paying taxes. As a result, many investors have postponed taking profits until the new year, delaying tax liability by up to 15 months.
Another factor in the short-term weakness was over-enthusiasm. Everyone was optimistic. Such an extreme sentiment indicator often signals a short-term correction. The biggest factor behind the sell-off at the beginning of the year is the unexpected strength of the economy. The December 2023 jobs report, including key hourly wage data, was stronger than expected. Amid a better-than-expected economic outlook, the Atlanta Federal Reserve raised its fourth-quarter GDP forecast to 2.5%. The market is reducing its expectations of interest rate cuts by the Fed. The market had expected interest rate cuts of 150 basis points, or 1.5%, in 2024.
Traders now believe there is a 57% chance the Fed will cut interest rates at its March meeting. Just a week ago the probability was almost 100%. Simply put: expectations have been reset.
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Still, the outlook for stocks in 2024 is positive. The Fed will cut interest rates in the first half of 2024. The inflation target of 2% was achieved on a six-month basis. Additionally, the real-time housing inflation rate is 1% or less, while the real-time housing inflation rate is 5% to 6%, according to the Bureau of Labor Statistics. With real inflation at 2% and a target federal funds rate of 5.25% to 5.5%, the policy is extremely restrictive.
This point deserves emphasis: real interest rates are at least 2% higher than the neutral rate, which is overly restrictive. Such restrictive policies could cause something to “break” in the economy. It is slowing and the labor market is normalizing, suggesting that wage rates will continue to fall. Conclusion: The Fed will cut interest rates. The Nasdaq Composite and the broader market will rise. Investing in a diversified stock portfolio is the best way to build long-term wealth. Keep the faith.
The author owns shares in Alphabet-Google, Meta, Microsoft and Nvidia.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and economics, politics, sociology and criminal justice.
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