The anatomy of Nasdaq 100 drawdowns and investor psychology

Equities 6 minutes to read
Peter Garnry

Head of Equity Strategy

Summary:  The Nasdaq 100 is currently in its 15th largest drawdown since 1 January 2003 down 10.9%. History suggests that the drawdown could last 121 trading days if this is an average drawdown in terms of its recovery profile. This we think would profoundly alter investor psychology as the new group of retail investors arriving at equity markets last year have never experienced slow grinding equity markets for very long. Our thesis is that growth investing and its near term support will hinge on the drawdown length and thus is a key indicator to monitor going forward.


Nasdaq 100 is 15 trading sessions into the current drawdown down 10.9%and our bubble stocks basket is down 27.9% since the peak. Listening to many growth investors, both professional and retail, it has been a violent move, and many has been taken by surprise, or at least, many had underestimated the interest rate sensitivity and given it much thought. While painful for many investors we could see our bubble stocks basket experiencing a 50% drawdown taking the basket’s total return index back to levels from September last year – if this happens it would entail a 32% decline in bubble stocks from current levels. Outsized gains typically come with subsequent volatility and potentially dramatic drawdowns. That is the lesson of history, and this is no different.

Source: Bloomberg

Every drawdown has its unique cause and comparisons should be made with great caution, but when you face a drawdown of meaningful size you need to get your statistical prior right. The current drawdown is the 15th largest since 1 January 2003, so while it has felt dramatic to many investors it is still a benign correction. The median and mean drawdown length of these 15 drawdowns are 121 and 157 trading days respectively, so the current drawdown could extend for 6-9 months if this is an average drawdown.

What is important to investor psychology is the drawdown length. This was one of the main reasons retail investors left the equity market after the dot-com bubble burst. Investors are impatient people despite many argue they invest for the long term. The drawdown after the financial crisis in 2008 and the subsequent unemployment rate was also detriment for retail investor participation. Even has late into the current bull market as 2016 and 2017 you can find many articles on where the retail investor is in equity markets, and whether they will ever come back. There are also many mentioning of young people and women nor participating.

Source: Bloomberg and Saxo Group

But the last couple of years bull market, improving labour market dynamics, a larger focus than ever by media on technology stocks, the rise of crypto and Tesla, have pulled many young people and women into the game of equity investing. Many arrived during the rebound phase last year when many people were forced into lockdowns. This means that a lot of the new marginal buyer of technology stocks have never seen a drawdown and not a drawdown of proper length. Therefore our thesis is that if this becomes a lengthy drawdown in technology stocks due to higher inflation and interest rates, then it will alter the investor psychology of growth investing and many will become impatient and shift strategies or maybe even leave the market. It is only really fun when returns come fast and easy.

The chart below shows the 15 drawdowns and their recovery profile. The blue line is the recovery after the Covid-19 pandemic started the historic sell-off last year. This is still the fastest recovery ever in history from such a large drawdown that reached 27.7% at the bottom and a recovery that took many quant strategies and tactical asset allocation strategies by surprise. The orange line is the current drawdown and something we will be monitoring for some time as it shapes investor psychology.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Support Centre
For existing clients, please click here to request support via the Support Centre.

Have a question about our products, platforms or services? Visit the Support Centre to find answers for our most frequently asked questions. If you are still unable to locate an answer to your question, you will also find contact details for your local Saxo office to speak with a representative.

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.