Nasdaq is poised to underperform S&P 500 for first time since 2016 as investors shun tech stocks

For the first time in five years, tech investors aren’t the life of the Wall Street party.

As 2021 winds down, the tech-heavy Nasdaq Composite is up 23% for the year, trailing the S&P 500, which has climbed 28%, through Monday. The last two times the S&P 500 topped the Nasdaq occurred in 2016 and 2011.

Tech stocks have four days left to make up that difference, but the last week of the year doesn’t tend to bring much news that would spur an outsized rally. Indexes were up across the board on Monday, with the S&P 500 climbing to a record.

The Nasdaq started 2021 strong, picking up where it left off in 2020, almost doubling up the S&P 500’s gains by mid-February. Then trading tailed off with the arrival of the first Covid-19 vaccines, which raised hopes among investors that the U.S. was on the verge of getting through the pandemic, potentially lessening demand for remote work technology, home workout systems, food delivery apps and tech-based living room entertainment.

Next, inflation reared its head, topping 4% in April, then as high as 6.8% in November. The Federal Reserve initially expected rising prices to be transitory, but they persisted, spurring the central bank to take a more engaged stance, citing expectations for rate hikes in 2022.

That’s created a double whammy for high-multiple tech stocks. Investors are worried about the demand side of some of their businesses, and they’re also rotating into sectors of the market that tend to hold up better in a rising rate environment.

“All the stay-at-home, play-at-home, work-from-home stocks were DOA in 2021, like the pandemic didn’t exist anymore,” said Jake Dollarhide, CEO of Longbow Asset Management in Tulsa, Okla. “The last five years, every time it looked like there would be a rotation out of tech, everybody bought the dip — 2021 will go down as the year that investors did not buy the dip in tech.”

Within the S&P 500, the top-performing subgroup of the year was energy, reflecting soaring gas prices. Next came real estate, which delivers high dividends and has benefited from surging demand for warehouse space and residential properties.

Tech isn’t too far behind, mostly because mega-cap companies Apple and Microsoft have held up well and make up so much of the tech subgroup, and the overall S&P 500. Alphabet and Meta Platforms (formerly Facebook) are part of the communication services sub-index and Amazon is in the consumer discretionary group. Both have slightly underperformed the broader index.

The main problem for the Nasdaq has been the plunging value of companies that picked up huge market caps in 2020, only to see investors turn against them this year.

Zoom stock has dropped 45% this year, after last year’s 326% increase in revenue led to a quintupling in its stock price. Peloton, meanwhile, has plummeted 76% after revenue growth peaked at 232% in mid-2020, pushing the stock up over 430% for the year.

Twilio, Spotify and Block (formerly Square) have each fallen more than 20% this year and PayPal is down 18%. The WisdomTree Cloud Computing ETF, a basket of publicly traded cloud software companies, is about flat for the year after more than doubling in 2020.

“I pointed out to clients, if you’re heavy tech, you’re likely to underperform the overall market,” said Dollarhide. “But keep in mind how much you’ve overperformed the market the last three to four years,”

In 2020, the Nasdaq climbed 44%, while the S&P 500 rose just 16%. From the end of 2016 to the close of 2020, the Nasdaq won every year, rising a total of 139% compared to the S&P 500’s 68% increase.

Dollarhide said he’s used the recent pullback to buy shares of some companies that he sees as well positioned for the future even if they’ve fallen out of favor of late. DocuSign, for example, is down 30% this year after more than tripling in 2020. Dollarhide said his firm, through its relationship with Charles Schwab, is constantly using DocuSign, because Schwab “eliminated faxes, paper forms, and it’s the only way you can open a new account these days.”

“I’m using DocuSign five, six, seven times a day, where as I was doing faxes or mailings five, six, seven times a day,” he said.

Another purchase he made was Zillow, which has plunged over 50% this year, mostly because of the company’s failed effort to crack the home-flipping market. The company exited the business in November after racking up a loss of over $328 million in the latest quarter.

“Zillow is just a classic misstep,” Dollarhide said. “Getting into and flipping houses — that’s a terrible idea. We bought on that dip. It’s an overreaction to the downside. They lost their way, frankly.” For investors like Dollarhide, DocuSign, Zillow and even Zoom make for individual buying opportunities.

To be sure, the performance difference between the two indexes isn’t as notable as it used to be, with the Nasdaq and S&P 500 starting to look more alike.

The seven companies with the heftiest weightings in the S&P 500 — Apple, Microsoft, Alphabet, Amazon, Tesla, Meta and Nvidia — now make up about 27% of the index. They’re also the bulkiest members of the Nasdaq, which is the main reason why the two indexes’ growth this year are separated by only a few percentage points.

“The market is becoming increasingly FAANG,” said Tom Lee, managing partner at Fundstrat Global Advisors, referring to Facebook, Apple, Amazon, Netflix and Google.

Lee, speaking on CNBC’s “Halftime Report” on Monday, said he views FAANG as more than just those companies, and includes other tech leaders with large market share and pricing power. While he’s concerned about the impact of inflation and rates on the overall market, Lee said FAANG stocks are his second favorite pick, behind energy, heading into 2022.

“If there’s panic around inflation and Fed tightening, the rest of the market takes it on the chin pretty hard,” Lee said. “I think FAANG is pretty solid in the first half and everything else looks really shaky.”

WATCH: Here’s why Fundstrat’s Tom Lee sees a pullback coming in 2022