Could the Dow Finally Beat the Nasdaq in 2022?

The Dow Jones Industrial Average (DJIA) produced a 245% total return in the 10 years between Jan. 1, 2012, and Dec. 31, 2021. That’s a return any investor would likely be happy about until you realize the S&P 500 produced a 302% total return during that time frame, and the Nasdaq Composite rose 476%.

In fact, the Nasdaq Composite beat the Dow nine out of the last 10 years. It’s a rivalry rooted in growth versus value and income; of megatech companies versus the broader economy. Here’s why the Dow could finally beat the Nasdaq in 2022, and if that happens, what it means for your portfolio.

Image source: Getty Images.

The power of big tech

The S&P 500 doubled between Jan. 1, 2019, and the end of 2021. It was the best three-year performance since the late 1990s. And it was fueled mostly by big tech stocks.

Top S&P 500 components like Apple (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT) continued to grow revenue and earnings even when faced with the onset of the pandemic. And Apple just posted its best year in company history when it reported fourth-quarter and full-year 2021 earnings on Thursday.

The Nasdaq Composite Outperformed the DJIA in Nine of the Past 10 Years

Total Return (Decline)

2021

2020

2019

2018

2017

2016

2015

2014

2013

2012

DJIA

20.1%

9.7%

25.3%

(3.5%)

28.1%

16.5%

0.2%

10%

29.7%

0.8%

Nasdaq Composite

22.2%

44.9%

36.7%

(2.8%)

29.6%

8.9%

7%

14.8%

40.1%

0.9%

Data source: YCharts.

Aside from strong performances, many tech stocks have also benefited from what’s called “multiple expansion,” which happens when the market is willing to pay a premium for a stock relative to its sales or earnings. This can happen if growth rates are increasing or if the market is more optimistic about the prospects of a company. For Apple and Microsoft, the dual effect of growing sales and earnings paired with multiple expansion helped the companies add a combined $4 trillion in market cap to the S&P 500 over the last three years.

In the chart below, we see that Apple and Microsoft both have a price-to-earnings (P/E) ratio above 30, and their price-to-sales (P/S) ratios are at their highest levels in five years.

AAPL P/S ratio. Data by YCharts.

Such strong multiyear performances from heavily weighted Nasdaq components like Apple, Microsoft, Alphabet, Amazon, Meta Platforms, Tesla, and Nvidia can make up for a lot of underperformance from lighter-weighted components. It’s also worth mentioning that Apple and Microsoft are both Dow components. So really, when we talk about the Dow beating the Nasdaq, it’s not like the Dow has to beat Apple and Microsoft, it’s more like the Dow would likely have to outperform the tech sector in general.

It pays not to wait

Occam’s razor states that “plurality should not be posited without necessity.” In modern English, it means that it is better not to overcomplicate a situation unnecessarily, and the simplest explanation is usually the best.

The simplest reason the Dow could beat the Nasdaq in 2022 is that Dow components are a better value in today’s economy, while many Nasdaq components are overvalued. But for the sake of argument, let’s also expand upon the more complicated points that back this claim.

The Dow will likely beat the Nasdaq if sectors outside of tech are producing the bulk of the market’s gains. Large tech stocks like Apple and Microsoft could continue putting up decent numbers. But smaller tech companies, especially unprofitable tech companies that depend on debt, could have a harder time growing their businesses amid high interest rates.

Many of these businesses are valued based on their future earnings and cash flows. A weakening dollar (inflation) dilutes the value of future dollars. By contrast, low interest rates and low inflation mean it’s less important whether you get a dollar today or a year or two from now. Businesses that earn high profits now, which are industry-leading companies like those in the Dow, are better suited for today’s inflationary economy and tighter monetary policy.

A shift from growth to value

The Dow is chock-full of value stocks with low price-to-earnings ratios and a history of paying dividends. Two examples are Caterpillar (NYSE: CAT) and 3M (NYSE: MMM) — which both reported record-high earnings last week. Based on their 2021 earnings per diluted share, Caterpillar has a P/E of 17 and 3M has a P/E of 16, which are both far lower than the market average.

It’s still early in 2022, but so far the market is showing that value investing is back in style. This is good news for folks who prefer owning blue chip businesses they are familiar with instead of hot tech stocks they barely understand. It’s also better for folks who prefer less volatility and more passive income, as many value stocks tend to pay dividends. This doesn’t necessarily mean you should sell growth stocks and buy value stocks. But it does present the possibility of value stocks outperforming the market, not to mention some bargain buys in oversold growth stocks.

An early lead

If the Dow were to ever beat the Nasdaq Composite, it would be this year. So far, the Dow is down 6% for the year, while the S&P 500 is down 9% and the Nasdaq is down 15%. Whether the Dow beats the Nasdaq or not is more for bragging rights than anything else. The most important thing for the individual investor is to own companies that suit your risk tolerance, and that you like, understand, and believe in for the long term.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Daniel Foelber has the following options: long February 2022 $185 puts on Apple and short February 2022 $180 puts on Apple. The Motley Fool owns and recommends Alphabet (A shares), Amazon, Apple, Meta Platforms, Inc., Microsoft, Nvidia, and Tesla. The Motley Fool recommends 3M and Alphabet (C shares) and recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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