Fundamental Forecast for the Nasdaq 100 and Dow Jones Index for the Third Quarter At the start of Q3, the Nasdaq 100 index is on its way to new highs. The tech-heavy index benefits from a flattening Treasury yield curve. A sudden rise in short-term rates could make the Dow Jones more vulnerable. View each DailyFX Analyst’s favorite trades for the third quarter. From the DailyFX Free Trading Guides, download our new 3Q top trading chances guide! At the start of Q3, the Nasdaq 100 index is heading for all-time highs, fueled by earnings optimism as the economy recovers from the depths of the Covid-19 outbreak. At its June meeting, the Federal Reserve raised its forecast for US GDP growth this year to 7.0 percent, highlighting solid momentum while voicing concerns about inflation. According to the dot plot, the June FOMC meeting might be a turning point for the central bank’s monetary policy stance, with a majority of Fed policymakers hinting at two rate hikes before the end of 2023. A discussion on reducing monthly asset purchases has begun among key members. The US Treasury yield curve flattened as investors tried to price in earlier Fed rate rises and a gradual tapering path as a result of these developments. Following the June meeting, the 10-year Treasury yield spread fell to 118 basis points, a significant drop from the recent high of 156 basis points reached at the end of March (chart below). In the previous rate-hike cycle, a sharp reduction in the 10-year yield spread was followed by the Fed’s announcement in 2013 that QE would be tapered. During a tapering cycle, front-dated yields tend to climb quicker than longer-dated yields. A hawkish shift in the Federal Reserve’s monetary policy stance might usher in yet another period of Nasdaq 100 outperformance over the Dow Jones Industrial Average. Because the front-end borrowing costs climb quicker than the longer-end rates, a flattening Treasury yield curve makes the tech-heavy index more desirable. Because their values are geared toward long-term growth potential, large-cap technology companies like Amazon, Tesla, and Netflix are particularly sensitive to longer-dated borrowing costs. Smaller technology start-ups are also less vulnerable to short-term borrowing costs because venture funding is typically spent for 5-10 years or more. Value Stocks’ Vulnerability Value companies like McDonald’s, 3M, and Coca-Cola, on the other hand, may be more vulnerable to a sudden spike in short-term rates for the Dow Jones Industrial Average. This is because increasing short-end borrowing costs make dividend-paying equities less appealing to investors than they were when interest rates were ultra-low. Over the last six months, the Nasdaq 100/Dow Jones ratio has shown a negative correlation with the US 10-year yield spread, indicating the prospect of trading the Nasdaq 100 vs Dow Jones spread as we approach a rate-hike cycle. However, if inflationary pressures become persistent and sticky, longer-dated yields may begin to catch up to front-end rates, resulting in a steepening yield curve. Traders may consider doing the opposite in this circumstance, i.e., looking for the Dow Jones to outperform the Nasdaq 100. Margaret Yang’s Nasdaq 100/Dow Jones Ratio vs. US 10-2 Yr Yield SpreadChart, created with TradingView View each DailyFX Analyst’s favorite trades for the third quarter. From the DailyFX Free Trading Guides, download our new 3Q top trading chances guide! —- Margaret Yang, a DailyFX.com strategist, wrote this article. Use the comments area below to reach out to Daniel, or follow him on Twitter at @ddubrovskyFX./n
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