Nasdaq dropped to lows since October 2020

Yesterday the Nasdaq 100 Index (NDX) lost another 1% dropping below 11,000 points.

This represents a level that has not been touched since October 2020. 

Nasdaq: tech index hits October 2020 lows

With the collapse of the financial markets in March 2020, due to the onset of the pandemic, the value of this index fell as low as 7,000 points, but thanks to the Fed’s liquidity injections by the end of April it had already returned almost to 9,000 points. 

At the end of June of that year, it exceeded 10,000 points for the first time in history, making a new all-time high, while the first time it reached 11,000 was in mid-July, setting a new record. 

Thus the descent of the last few days brought it back to levels first reached in July 2020, thanks to the Fed’s mighty injection of liquidity into the financial markets, which in just four months had initially made up for all that had been lost with the onset of the pandemic, and then produced a further 14% rise. 

By August 2020 the continuation of growth due to Fed QE had slowed for a few months, to the extent that after a peak at over 12,000 points the Nasdaq 100 index had returned to 11,000 points by the end of October. Beginning in early November 2020, a further uptrend began that for nearly two years has not allowed NDX to return to the 11,000-point mark, which was knocked down yesterday with a close at 10,926. 

The peak of the 2021 bullrun was reached in November, with as many as 16,764 points. Since November 2020, the accumulated growth was 53%. 

However, as soon as the Fed stopped flooding the markets with liquidity, growth came to a halt, and when it began withdrawing liquidity to try to curb escalating inflation, the speculative bubble that had begun to form in April 2020 burst. 

The current level of the Nasdaq, probably not by chance, is what it reached in July 2020 when the first phase of growth resulting from QE stalled for a few months. Thus we can say that all the gains generated during the second phase of growth, namely from November 2020 to November 2021, during the most resounding phase of the speculative bubble, have been lost. 

Is the race to the bottom over?

At this point, it remains to be seen whether the deflation of this bubble will stop, since all the unwarranted growth accumulated during the second phase of the bullrun caused by QE has now been wiped out. 

After all, the current level is only 13% higher than the levels before the March 2020 crash, so it might even be a sustainable level given that the Fed certainly will not withdraw all the liquidity injected in 2020 and 2021 from the market. 

On the contrary, if from February 2020 to March 2022 the Fed’s balance sheet went from $4.2 trillion to an incredible $8.9 trillion, it has since only dropped to $8.759 trillion. So the withdrawal of liquidity from the markets is actually proceeding much more slowly than its injection, so much so that it is assumed that the Fed will not withdraw much of the liquidity it injected in 2020 and 2021. 

It is worth adding that this withdrawal has accelerated since mid-September, so it is in fact currently in its most acute phase. 

It is worth remembering that markets always anticipate events, so much so that the end of bullrun in November 2021 preceded the actual end of QE by several months. As soon as the Fed let it be known that it would reduce its purchases in the financial markets, thus reducing money creation in the process, the markets themselves almost immediately began to price in this reduction, so much so that the bullrun stopped. 

This happened while the Fed was still creating money to inject liquidity into financial markets, which means investors and speculators tried to anticipate the new trend that would inevitably lead to QT (Quantitative Tightening, the reverse of QE). 

Then when the Fed stopped creating money in April 2022, the markets immediately reacted with a further collapse, already preempting QT when it had not yet begun. 

In fact, on 4 April 2022 the second sharp phase of decline in the Nasdaq 100 Index of 2022 began, while the actual reduction in the Fed’s balance sheet began after mid-May. 

Markets always try to anticipate events by “discounting” possible future price news. So in reality the QT has already been predicted for some time, including its intensification. 

The third strong phase of decline in the Nasdaq 100 Index of 2022 began on 22 August, while the acceleration of QT began after mid-September. 

The evolution of monetary policy

To understand how markets might react in the coming weeks, or months, to further changes in the Fed’s monetary policy, it would be necessary to have a fairly clear idea of the direction the US central bank might take in this regard. 

Right now, there is indeed a lot of uncertainty, because while there is overbearing speculation circulating regarding a possible further tightening of the Fed’s current restrictive monetary policy, with ever-higher interest rates and a long-lasting QT, there are, on the other hand, those who believe that the Fed may sooner or later opt for a slight easing, given the economic situation. 

The risk that all this will help trigger a strong and lasting recession is there, so it is not unreasonable to imagine that the Fed may want to avoid this scenario by making its monetary policy a little less restrictive. 

It will most likely depend on inflation, because if it continues to fall as it has in the past two months there may in fact be room for a softening. If, on the other hand, the scenario were to re-escalate it could easily become even gloomier than it already is.