S.Market indices are not economics and vice versa. A colleague of mine took up the subject last summer and argued that the main differences were primarily a matter of size and period of measurement. However, most investors view the performance of benchmarks such as the Nasdaq 100 Index (NDX) as a reflection of the future outlook for economic activity.
The team at JPMorgan Wealth Management echoed this sentiment, saying, “Equity markets often bottom out well before a recession is over, and sometimes even before you realize you’re in a recession. It can bottom out,” he said, adding that “the stock market is open to the public.” It is traded 252 days a year. These are the best forward-looking mechanisms for economic growth and revenue. By definition, GDP is a backward growth rate. ”
So what, if anything, does NDX tell us about economic forecasts?
At first glance, it looks like the worst has passed when you look at NDX. Optimists would point out that the NDX has rebounded nearly 23% from its lows. A pessimist might argue that the index essentially measures what he sees in early 2021. Both are correct.
However, in early 2021, the cost was significantly lower than it is today. The Federal Funds rate for January 2021 was 9 basis points (0.09%). It’s now 508 basis points (or 5.08%). In other words, the average 30-year mortgage rate has risen from 2.65% to 6.50%. When tying interest rates to GDP, keep in mind that housing accounts for about 18% of US Gross Domestic Product.
degree of uncertainty
Another Wall Street adage claims that “bad certainty is better than uncertainty.” At this point, NDX levels suggest that the worst-case scenario is unlikely to occur. Corporate profit margins have slowed significantly in 2022, but remain historically strong. The bond market has suggested that interest rates may have peaked after the FOMC statement in May and the cost of capital may fall by the end of the year.
Nevertheless, just like in life, there is always some degree of uncertainty in markets. That reality is partly reflected in the increased trading volume of index options. Average monthly NDX volume in calendar year 2022 was just under 500,000, compared to just under 600,000 through April this year.
From my perspective, all types of investors generally have a better understanding of options. Individuals and institutions continue to be attracted to index options such as the Nasdaq 100 Index Options (NDX), the Nasdaq 100 Reduced Value Index Options (NQX) and the Nasdaq 100 Micro Index Options (XND) because they allow users to create defined risks. I’m here. You can set exposure based on sentiment (depending on your strategy) or manage downside risk over the life of the option.
Products that can reduce or eliminate uncertainty are inherently powerful. Index options allow market participants to answer historically vague questions. For example, what if the macro image deteriorates and the NDX retest is at its lowest (about 18.5% drop)?
Investors who own the Invesco QQQ Trust Series 1 ETF (QQQ) (or another NDX proxy) with option hedging can answer that question more accurately than those without index option hedging.
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The views and opinions expressed herein are those of the authors and do not necessarily reflect those of Nasdaq, Inc.