The Nasdaq: favours buy-and-sell traders

Blue-chips versus technology

When looking at opportunities to invest, market participants often compare the relative values of one sector to another. In 2009 in the US, technology stocks outperformed blue-chip stocks, with the Nasdaq rising almost 40% while the S&P500 rose only 20%.

This looks like a striking difference but it is actually not uncommon. If you had invested in the Nasdaq in 1999 you would have made a total return of 5% by 2010, while if you were invested in the S&P you would have made 10% over the same time. A decade that looks disappointing, at a cursory glance, was actually full of movement and hence opportunity for active 'buy-and-sell' traders. The decade included the dotcom bust in 2000, when the Nasdaq fell more than 80% from high to low, and the recent financial crisis when the S&P was down almost 60% at one stage.

During the first three years of the 'noughties' the Nasdaq consistently underperformed the S&P500. Then, in 2003, there was a reversal of fortunes, and both indices rallied strongly, but the Nasdaq fared better, rising 40% compared to the S&P's not so meagre 20% gain.

The evidence suggests the dotcom collapse in 2000 was an overshoot from expensive to cheap, compared to the bellwethers. Today we ask if the bellwethers have become cheap relative to the tech stocks?

In the last three years of the decade, with the financial crisis, the opposite relative strength trade occurred – the Nasdaq outperformed the S&P. After three years of underperformance, perhaps 2010 will be the S&P's year. We will monitor this closely for evidence that a reversal of fortune is on the way.

If you are not interested in trading the strengths of one index over the other, and are instead more focused on the general macro picture then you may want to take a look at some of the fundamentals over the past 10 years.

At the start of the last decade, the S&P500 fell by double-digit figures for three consecutive years, declining 40% in total. Over the three years, US unemployment averaged 4.8%, disposable income grew by 7.5% and the savings rate averaged 3% of disposable income. Over the past three years the S&P has declined by only 21%, but US unemployment averaged 6.5%, disposable income grew by only 2%, and the savings rate did not change at 3%.

Either investors were way too negative at the start of the decade, or they are way too optimistic today. We hold the belief that the latter is true and that the slump will be more protracted than many investors are pricing in. As such we believe equity prices are overvalued.

Dollar dominates trading

The currency markets continued to hold centre stage last week with a broad-based dollar rally sweeping the markets.

The EUR/USD was down 300 points by Wednesday evening, trading at 1.41, a level not seen since last August. The poor performance of the euro against the dollar can be largely attributed to the ongoing problems in Greece, poor economic figures from Germany, and the general equity sell-off. However, in a broader sense the dollar continues to gain traction on the back of speculation that the US is more likely to raise rates before the ECB and the fact that certain ECB member nations are expected to face prolonged economic difficulties.

Interestingly though, one of the biggest movers in the currency market hasn't involved the dollar and that is EUR/GBP. Last week, we suggested a technical trade going short EUR/GBP from 8,915 looking for a break though the support level at 8,830. The trade worked, with EUR/GBP falling over 2%, getting as low 8,650 on Tuesday. At the time of writing it is trading at 8,700 and any traders who did manage to get short should take profits now. Given the sharp fall we would expect some sort of retracement back higher, and from a technical perspective a move back toward 8,830, which should now act as a resistance level, would be another good opportunity to get short with a tight stop loss in place.

The AUD/USD (Aussie dollar) offers a good trading opportunity to go short. In December of last year the AUD/USD broke a solid upward trend-line and has since been trading in a sideways range. At the time of writing it is trading at 9,130 and we feel it could fall back to the bottom of the range at around 8,750 in the next few weeks.

The Aussie dollar is a commodity-driven currency, and over the past few weeks the rally in commodities has started to dissipate. Last week we saw more signs of commodities falling with gold down 3% and oil down 1.5%. The combination of these fundamental and technical factors provides a good trading opportunity but should be handled with good risk management.

Paddy Haran and Vinay Sharma, Delta Index