NASDAQ tumble resembles Tulipmania

What a difference a year makes! In March 2000, investors were revelling in the runaway success of the NASDAQ stock market. It hit an all-time high of 5048.62 on March 10, 2000.

On March 12, 2001, the NASDAQ Composite opened the weekly trading session at 2052.78. That’s a drop of 59.3 per cent, a stunning decline by any historical standard. And the end isn’t in sight.

What’s made the NASDAQ plunge even worse is the huge psychological impact. At the end of the ’90s, many people were convinced we had entered a whole new era, both for the economy and for stock markets.

  • ‘New Economy’ stocks were the place to be: the Internet, biotech, wireless communications, software development, e-commerce.
  • ‘Old Economy’ stocks were history. No one was interested in retailing, mining, forestry, transportation, media and the rest.

Classic bubble
To make matters worse, a new generation of analysts had appeared on the scene. They offered what appeared to be a plausible rationale for why the stock market had fundamentally changed. Sky-higmultiples were no longer a concern.

Growth was the key. Profits weren’t a consideration. The New Economy companies would be rolling in cash in a year or so. Traditional valuation techniques were passé. New times, new models, new attitudes. Many people believed it to be true. They were shattered to discover it wasn’t.

What we experienced was a classic bubble. They have surfaced again and again throughout history, yet we never learn.

  • The NASDAQ run-up was our generation’s version of Holland’s Tulipomania, that fabled period in the 17th century when tulip bulbs played the role of tech stocks, with crazed investors bidding up their prices to unbelievable levels.

Balloon always pops
Why don’t we learn? Because it is so easy to be caught up by the lure of easy money, especially when we see everyone around us getting rich-at least on paper. And as each frenzy takes hold, prominent voices can always be found to insist that “this time it’s different”-the time-tested laws that govern true value have somehow been repealed.

I have said it before and I repeat it again – it’s never different. You can only pump so much air into a balloon before it pops. NASDAQ’s balloon expanded to a tremendous size. But in the end, it too went poof.

So now what? The past year has been a nightmare for true tech believers. As of March 12, the drop had almost matched the worst decline in NASDAQ’s history, a 59.9 per cent plunge in 1973-74.

Where’s bottom?
However, that one was spread over 21 months. This one has happened in just 12. Even worse, it took more than five years for the Composite Index to recover from that tumble. It wasn’t until early 1979 that the market regained the level it has been at when the fall began on November 1, 1973.

And we don’t know that we have seen the bottom yet. It’s quite possible that by the time you read this we will have seen a new record for a NASDAQ bear market. And many NASDAQ stocks are still expensive when measured by traditional standards.

The average stock is selling at more than 100 times the most recent earnings, according to a study done by the U.S. company, InvesTech Research. Of course, many NASDAQ companies have no earnings at all, which exacerbates the problem.

Not far off
So it’s quite possible that the Index could drop below 2000, if it hasn’t already done so. Intel’s latest revenue warning really shook up investors and that could lead to more selling pressure when the week begins.

But we have to be getting close to the bottom. The average NASDAQ bear market has lasted 10 months and we’re past that now. Apart from the 1973-74 drop, the longest NASDAQ bear has been 15 months.

So unless we’re about to see a market slump that rivals that of the Great Depression, which I do not expect, we can expect to see NASDAQ bottom out and begin the long climb back sometime this year.

So the time is coming when investors looking to profit from the inevitable rebound should gradually begin to build new positions. I don’t believe it is here yet. But it’s not far off.
Adapted from the Internet Wealth Builder, a weekly e-mail investment newsletter edited and published by Gordon Pape.