Nasdaq 100 vs. S&P 500: Which Index Should You Consider

 The Nasdaq 100 index has certainly turned heads with its strong performance in recent years, often outpacing the S&P 500. This raises a key question for investors: Which index is the better bet, especially considering potential political shifts like a second Trump term? Let's dive into the historical data and underlying factors to help you decide.   

A Look Back: Historical Performance (1986-2024)

To understand the potential future, we first need to look at the past. The Nasdaq 100 was launched back on January 31, 1985. Comparing its performance against the S&P 500 from 1986 to 2024 reveals some interesting trends.  

Over the last 39 years, the Nasdaq 100 has shown periods of significant outperformance (excess return) compared to the S&P 500.  

• Peak Performance: The excess return hit a high of 80.91% in 1999.   
• Lowest Point: Conversely, it saw a low of -27.74% in 2000.   
• Average Advantage: The median excess return over this period is 1.24%.   

Based purely on history, investing in the Nasdaq 100 might seem appealing, as it has tended to outperform the S&P 500 over the long haul.   

The Risk Factor: Higher Highs, Deeper Lows

However, potential higher returns often come with higher risks.   

• Nasdaq 100 Drawdown: The Nasdaq 100 experienced a massive 83.5% drop (drawdown) after its peak on March 24, 2000. It then took a lengthy 15 and a half years to recover and surpass that previous high.   
• S&P 500 Drawdown: In comparison, the S&P 500's largest drop was 56.8%, which occurred during the 2008 financial crisis. Its longest recovery time after the 2000 dot-com bubble was 7 years.   

This leads to a crucial consideration: Is the potential extra 1.24% annual return worth the risk of significantly deeper and longer-lasting downturns?

Can You Time the Nasdaq 100 Market?

Could an investor just jump into the Nasdaq 100 during the "good times" to capture the gains and avoid the major drops?. To explore this, let's look at what might drive the Nasdaq 100's excess returns.   

Two theories were tested:   

1. Globalization Boost? Does increased globalization favor the Nasdaq 100? Using US trade as a percentage of GDP from 1986 to 2024 as a measure, there seems to be little to no correlation with the Nasdaq 100's excess return. So, this theory doesn't seem to hold up.   
2. Equity Risk Premium (ERP) Impact? Does the market's overall risk appetite (measured by ERP) affect performance? Yes, there appears to be a connection.
   • When ERP is low (investors are less risk-averse), market prices tend to rise, and the Nasdaq 100 often increases more than the S&P 500.   
   • When ERP is high (investors are more risk-averse), market prices tend to fall, and the Nasdaq 100 is likely to drop more than the S&P 500.   
      
   

Investment Considerations in Uncertain Times

Looking ahead, factors like policy uncertainty (as potentially seen in a second Trump term) can increase the ERP. Elevated ERP has been linked to recent market corrections. If this uncertainty continues and ERP stays high, historical patterns suggest we might see limited or no excess return from the Nasdaq 100 compared to the S&P 500 during such periods.   

Disclaimer: This analysis is based on historical data and specific theories. Past performance is not indicative of future results, and investment decisions should involve careful consideration of individual risk tolerance and financial goals.