"Impervious" Nasdaq Risks Big Downside If Mideast Conflict Spirals

Authored by Ven Ram, Bloomberg strategist,

Stock investors had looked pretty impervious to risk aversion until recently.

But with yields pushing higher, they have started making an about-turn. An escalation of the conflict in the Middle East may just be what sends indexes back to fair value, and that would mean a drop of 14% for the Nasdaq 100.

While the contours of any ensuing conflict are beyond of the scope of discussion here, a protracted ground invasion may just be what forces a broad rethink of valuations across markets - and that would be particularly troubling for equities that have ignored fundamentals.

The fair value is 12,877 for the Nasdaq 100.

That “par price” is bootstrapped from the assumption that technology stocks may be viewed as long-duration bonds.

The index has surged some 36% this year, a reflection of the enthusiasm surrounding the potential of artificial intelligence.

That frenzy has overlooked soaring Treasury yields. While it was easier for traders to overlook risk-free nominal yields as they climbed successively through 3% and 4%, rates above 5% pose a significant hurdle for the simple reason that the latter is often the discount rate most suited for several investor groups.

Foundations, for instance, are typically required to spend at least 5% of their asset value every year, so their targeted returns are generally around 7%+ - so as the discount rate gets higher and higher, the less in real returns they have to spend from.

So the longer Treasury yields stay above 5%, the more equities will suffer.

With the geopolitical backdrop appearing the most menacing it has in decades and with discount rates climbing higher and yet higher, the first port of call for the Nasdaq 100 will be just below 13,000.

The intensity of the conflict and how widespread it becomes will determine its path thereafter.