Nasdaq Surges Past 7000 Thanks to Brokerage Cash Hedge Fund Leverage and Euphoria

For a bull market whose hallmark emotion for nine years has been nagging doubt, this one is starting to breed believers.

Little by little, resistance is falling, as milestones such as 7,000 on the Nasdaq Composite Index are passed and new ones like 2,700 on the S&P 500 and 25,000 on the Dow Jones Industrial Average come into view.

People sometimes talk about “dry powder” with individual investors. According to Morgan Stanley, there isn’t much left, going by unspent money in individual brokerage accounts. Cash as a percentage of assets at Charles Schwab Corp. clients has fallen to 11 percent, the lowest level since at least 1995.

Among professionals, the use of borrowed cash are surging. Leverage among hedge fund managers who speculate on rising and falling shares is approaching its 2007 high, data compiled by Morgan Stanley on its clients show.

“Our call for investor euphoria to appear in 2017 has finally arrived,” Mike Wilson, Morgan Stanley’s chief U.S. equity strategist, wrote in a note earlier. “Never have we witnessed such high gross leverage by long/short equity funds on a delta/beta adjusted basis. Individual investors are also finally getting involved as tax cuts likely becoming reality.”

Fear of missing out is rampant as stocks push to new highs day by day. Up 0.7 percent at 24,826, the Dow is heading for its 70th record high of the year, poised to surpass 1995 as the most ever. The same is true for the Nasdaq Composite. After a 30 percent rally, the gauge has made 72 fresh highs, more than any other years.

Tech stocks are reasserting leadership after a selloff in November proved brief. While Wall Street strategists have been debating on whether they’ll surrender supremacy to financial shares next year, investors keep chasing winners.

The Nasdaq Composite rose 0.8 percent as of 2:30 p.m. in New York, after briefly crossing 7,000 for the first time ever, beating the 0.6 percent gain in the S&P 500. With year-to-date gains doubling the market, tech has performed the best in the S&P 500.

Then again. While tech’s dominance may be reminiscent of the bubble years, the pace of gains is nowhere near levels seen during the 1990s. The Nasdaq has risen at 22.9 percent a year since the bull market began in 2009, trailing the 29.8 percent over the comparable period that led to the 2000 peak of the dot-com era.

Unlike the dot-com era, when investors snapped up web companies with promise but little profit, today’s gains are built on earnings. According to an estimate by Sanford C. Bernstein, tech earnings expectations have outpaced other industries every year since 2014, with the growth rate double the market. Adjusted for that, share gains have actually been slower.

As a result, the industry’s price-to-earnings ratio has contracted relative to the market. At 3 percent, their premium trails the 40-year average of 23 percent.

Toni Sacconaghi and Ann Larson, analysts with Bernstein, recommend that investors continue to favor the industry. Their November survey of clients showed tech spending among firms rose to a 14-year high. While tech companies are expected to see less profit boost from the proposed cut in the corporate tax rate, repatriated cash from overseas could lead to “material” share buybacks, they wrote in a note Monday.

“Investors should maintain a barbell of inexpensive value and expensive growth stocks in tech,” they wrote. “More expensive stocks trade at slightly above mean historical levels vs. value stocks, but that their longer term expected growth is similarly higher.”

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