How low can it go?

Momentum has turned in tech stocks and investors awakening from dreams of artificial-intelligence nirvana are back to a less grandiose concern: When will the selling stop?

Down 11% from its July high, the Nasdaq 100 has now erased about a third of its AI-fueled advance, including a bruising two days that just lopped about $800 billion off share values. There’s probably more pain in store, ventured strategists and traders queried Thursday, saying price-earnings ratios have room to compress and that Treasury volatility remains too high to declare a bottom with confidence.

Nobody, of course, knows where it will end, including whether it’s already over. But here are frameworks for how to think about where a floor might be formed. Estimates are drawn from a mix of technical analysis, valuation comparisons and how much more drubbing is in store for the AI oligarchy that propelled the gains.

Back to March

While valuations were a poor tool for market timing on the way up, during reversals they sometimes work as thresholds for sentiment, as traders spy entry points. The average valuation premium of the Nasdaq 100 Index verses the S&P 500 comes out to around 30% over the past 10 years. All else equal, restoring that equilibrium requires a fall to 12,500, a level last seen in March, according to Sameer Samana, senior global market strategist at Wells Fargo Investment Institute.

“That’s probably where long-term investors will start to kick the tires, especially given some of the themes that the index is benefiting from,” Samana said. “The open-ended questions are do rates find a home around 5%, or do they go higher. And is there a recession and how hard does it hit the EPS of these growth companies?”

‘The rest of the market catches up’

For Kevin Gordon, senior investment strategist at Charles Schwab, the valuations gap between the biggest seven tech companies and the average stock in the S&P 500 made the current selloff inevitable. He sees further losses for big tech while the rest of the market catches up.

Even with the Nasdaq 100’s price-earnings ratio falling from 35 to just under 30 in three months, there is more room for the index to get closer to its historic averages, according to Gordon. The big catalysts for this are likely to be multiple compression and a downward revision to forward earnings estimates.

Rising rates increasing the competition for capital may further exacerbate the selloff and sharpen the move. Currently, 10-year Treasuries are yielding about the same as the S&P 500’s earnings yield.

“I actually think it would be healthy to see more air come out of the ‘high fliers’ while the rest of the market catches up,” Gordon said. “One of the main risks we’ve been highlighting since the summer is the fact that the rest of the market (excluding the Super 7) was underperforming the S&P 500 by a degree we’ve never seen.”

‘10% from where they started’

For Chris Zaccarelli, chief investment officer at Independent Advisor Alliance, the selloff that started this week could easily morph into a fresh 10% drop for the Nasdaq 100. The tech-heavy index started the week around 14,600 and for Zaccarelli a drop closer to 13,000 isn’t implausible — maybe even by the start of November if Apple Inc.’s earnings disappoint. The index closed Thursday at 14,110.

The median price-to-earnings ratio of the eight big tech stocks — Apple Inc., Amazon.com Inc., Alphabet Inc., Meta Plaforms Inc., Tesla Inc., Nvidia Corp., Microsoft Corp. and Netflix Inc. — stands at 35.4, above its long-term mean of 28, data compiled by Ned Davis Research show. Strip out the post-pandemic rally in 2020 and 2021, and that’s near an all-time high, data compiled by NDR’s Rob Anderson show.

The Nasdaq 100 lost 2.5% on Wednesday — its worst day this year — as Google-parent Alphabet’s disappointing cloud results outweighed Microsoft Corp.’s strong sales. It slumped nearly another 2% Thursday after Meta Platforms Inc. doused hopes for a long-term advertising recovery and a reading on gross domestic product showed the economy running hot enough to rekindle worries of more Fed tightening. Amazon.com shares were up in late trading as investors digested its earnings report.

“The biggest driver is an earnings release and it can happen almost instantaneously or over the course of a single day,” Zaccarelli said. “10% is halfway between recession and unchanged. It’s an estimate showing additional uncertainty as opposed to an actual recession, which still hasn’t happened and GDP at +5% is a long way from a negative number.”

All about the rates

Take out the megacap bias of the Nasdaq 100 Index, and the bleeding becomes less severe. An equal-weighted version of the gauge, which makes little distinction between Amazon.com and Lucid Group Inc. is on track for the best week since July relative to its cap-weighted peer.

“You can say that the selloff will stop when the cap-weighed index reaches the equal-weighted index and be right, but this is an interest rate-driven rout, so ultimately it all depends on the Fed,” said Michael Matousek, head trader at US Global Investors. “You can point to a number and say, yes, the valuation is finally attractive, but it wouldn’t matter if rates keep pushing higher as fast as they did. It’s an interest-rate game at this point.”

At present, the cap-weighted Nasdaq 100 remains up 29% on the year, while its equal-weight version has risen 11%.