NASDAQ Overvalued!

By on October 22, 2006

Originally published in December 1999:

Year-end 1999 Issue

INDEXES ON 12/10/99

DJIA 11,224.70

S&P 500 1,417.04

NASDAQ 3,620.24

Editorial

I knew there would be days like these. I just didn’t think they could be this bad. I’m afraid the collective reasoning of the investing public is now pointing towards madness and delusion. That is why I’ve been compelled to leave my cave and write this issue. This perplexing market has forced me to respond. It has not been a good year in spite of the story the averages tell. The aggressive portfolio has been infected with advance/decline line disease and thus is underperforming miserably. Thankfully, the conservative portfolio has been spared this indignity. There is not much more to say, but more will be said.

The indexes pierce new highs on days when there are 20 new yearly highs and 240 new yearly lows. The NASDAQ explodes onward and upward when declining stocks outnumber advancing ones by a ratio of 5 to 3. This IPO-crazed market is ugly and it makes me ill to look at it. Money is being sucked out of anything holding any semblance of value and being funneled into a few companies building “castles in the air.” Maybe I’m just completely wrongheaded, but when you see companies like JDS Uniphase (NASDAQ: JDSU; 244 1/4), QUALCOMM (NASDAQ: QCOM; 391 1/2), and Yahoo! (NASDAQ: YHOO; 353 1/2) flying into the stratosphere on very flimsy underpinnings it just makes you wonder what people are thinking. Haven’t they heard of something called competition! The momentum fans should become familiar with the term because competitive forces are a very powerful and leveling concept. Sure, advances in technology are certain to change our lives for the better and the way investors are shoveling money at these companies there will certainly be some nifty devices and bandwidth advances heading our way. I’m looking forward to all of the new and exciting stuff, but these companies do not and probably will not have a monopoly that a company like Microsoft has enjoyed for the past decade. However, they are priced as if they do; in fact, they are way past that. James Stack recently pointed out that the entire NASDAQ indexes price/earnings ratio is an astounding 175! Believe me, there will not be that many winners. Of course, until this thing turns, the builders of the “castles” are right and I’m wrong; terribly wrong. And so the pain of underperformance will continue until it ends, and no one, absolutely no one, can say when that is. But this will surely end and when it does; boy will there be hell to pay.

On a more reasoned note, it is probably best to avoid any major new commitments to stocks right now. I recall back in the summer of 1982 when the Dow was around 800 and it didn’t look like it was ever going to move higher. Back then the Prime Rate was the interest rate everyone concentrated on, much like the long bond rate is the source of fascination today. The Prime Rate is the rate of interest given to the most qualified and financially hardy borrowers. The Prime was near an astounding 20% at its peak in ’82. The rate started to fall in the early summer and by August had dropped to 14%. It wasn’t until it had dropped 600 basis points by August of 1982 that stocks began to make their historical move northward. It was if investors could not believe that things were going to get better and inflation would ever go away. Investors had to witness a drop by 1/3 in the rate of interest before they would start buying stocks en masse. The market subsequently blasted off and has not looked back, except for a few short lived panics. The situation seems completely opposite today. The long bond rate has moved from 4.75% to 6.2% over the past year and yet investors have basically shrugged it off. It is if they can’t believe inflation will ever rear its head again. The move up in interest rates is similar in relative terms to the drop in 1982. Since ’82 the Dow has risen more than 1,000 percent. The lesson here is that it is time to be very cautious. Any further weakness in the long bond could trigger a sell-off of monumental proportions just like the bull market’s birth saw in ’82. With the distortions growing greater each passing day, the wheels could fall off this bandwagon at any time.

My father passed away recently. If you have heard about or read the book “The Millionaire Next Door” it describes my dad almost perfectly. He was a very frugal man; sometimes to a fault. He drove cars for eons before replacing them, resided in the house he paid cash for back in the late 50’s, and rode his bicycle for recreation. He was very friendly to planet earth, using up few of her resources and picking up trash whenever he saw it during his 20-30 mile jaunts. He developed a keen interest in the stock market in the early 70’s. He was purely a value investor and had a disdain for technical analysis. He bought stocks he determined were cheap without any regard to the prevailing fads of the time and disregarded the bullish or bearish trends in the market. My father believed in leverage and had a margin account which he built into quite a substantial portfolio over the years. He lived through several margin calls, but never panicked in any of the bear markets he experienced. Even though he saw his account drop by more than 50% several times he stuck to his discipline. I have contemplated changing course in this nightmarish market of individual stocks (most of which have been losing value) and moving exclusively towards low-cost index funds, but have decided to stick these hard times out as a tribute to his fortitude.

The NASDAQ is currently the strongest market on the planet and it is not reasonable to try to compete with it. The S&P 500 also has a strong technology bias now, so I don’t expect to beat it under the current market circumstances. It’s my feeling that it is way too late to jump on the high tech bandwagon like so many are doing. The gravitational pull (black hole) of the internet, semiconductor, wireless communications equipment/backbone, and Linux sectors is unmistakably sucking money out of the rest of the market and creating more interesting opportunities than I’ve seen in a long time. In my opinion, the most enticing, high risk side bet at this very moment is shorting the NASDAQ 100 (AMEX: QQQ; 159 13/16). Disclosure: I personally made this bet a few months ago and needless to say, it has been a big mistake up until now. The NASDAQ 100 is frothy, insane speculation personified. I expect a minimum decline of 30% to occur within 6 months. Remember, there are no guarantees from the management.

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