Nearly half of the Nasdaq is tech companies and it has outperformed every other index so far this year; is it a better investment than the S&P 500?
The Nasdaq (NYSEARCA: QQQ) is at its highest price since making its debut in 1971 and is up over 31% this year as of August 31; that’s nearly four times more than the S&P 500 (NYSEARCA: VOO), which is up only 8.25% this year. This is thanks to the pandemic, which gave tech and communication service sector stocks — which includes powerhouses like Amazon, Facebook, Alphabet, and Netflix — a nice boost. They are nearly 75% of the Nasdaq’s weight but only about 39% of the S&P 500’s. Additionally, both index prices are determined differently; the Nasdaq takes a company’s entire market cap whereas the S&P 500 uses a free-float market cap methodology.
The latter formula only considers a company’s outstanding shares and not shares that are held by insiders, governments, or cross-held by other companies. This gives the company less weight in the index and hence a lower price fluctuation representation. This would mean that the second-most valuable company in the U.S., Amazon, with 15% of its shares held by insiders, affects the price of the S&P 500 less than that of the Nasdaq.
The Bull Case For the Nasdaq
The main reason for investing in the Nasdaq is because of its significant tech and communications coverage; both sectors had an amazing decade, up 402% and 151%, respectively. Moreover, the recent outbreak has given the sectors an additional upswing as e-commerce, cloud services, OTT and social networking took center stage in people’s lives. That’s the past and the present. In the future, cloud services will continue to grow as a work-from-home culture will be adopted by many companies like Facebook and 20% of the global workforce is expected to work remotely post-pandemic; also, with the 5G revolution just around the corner, communication services will see a boost.
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The Bear Case For the Nasdaq
The same reasons for investing in the Nasdaq can be used as a warning; it’s like having most of your eggs in one basket. What if the tech or communications sector collapses like in the dot-com bubble burst of 2001-2002? At that time, the Nasdaq suffered a 77% drop while the broader S&P 500 fell around 49%. Furthermore, four of the world’s biggest companies have been involved in a House Judiciary Antitrust Subcommittee hearing recently, with recommendations pending. These can go well for the companies or can fare poorly; and if they do go well, how long will it be before another hearing emerges for these mammoth organizations, threatening to break them up?
Should the Nasdaq Become the New Benchmark?
Ultimately, investing in indexes and ETFs is about diversification and the S&P 500 is the standard benchmark for investors because it covers a wide range of industries and has a weighting mechanism that is more reflective of the overall market. Although the Nasdaq has been a wonderful index for investors this year and in the last decade, I don’t feel that it’s the best overall picture of the stock market as it is highly skewed towards tech companies.