NASDAQ Upward Channel Support

By on November 14, 2006

Originally Published in April 2001:

INDEXES ON 3/9/01

DJIA 10,644.62

S&P 500 1,233.42

NASDAQ 2,052.78

Editorial

It has been a year since the NASDAQ composite index poked through the 5,000 level. It goes without saying things have changed drastically in the past year. Many prognosticators now believe the NASDAQ will have a difficult time holding above the 2,000 mark. Investors have switched from unbridled faith in the future of technology and the companies that supply it, to a pessimism that holds out slight hope for a rebound. The technology boom over the past several years created the same problem previous booms have wrought; a tremendous oversupply of bandwidth, cell phones, chips and all other things technological. When money gets thrown at one area of the economy like it was heaped on the technology sector in 1999 and early 2000, bad things are bound to happen. The problem has been magnified by the fact that a great deal of borrowed money paid for the increased capacity to supply technology that there is significantly less demand for now. The slowing economy has made the oversupply of technology especially problematical.

In spite of all the gloom, there is a glimmer of hope and it lies in the chart below:

I’ve taken this logarithmic 10 year chart of the NASDAQ composite provided by the fine people at Stockcharts.com and drawn a straight line along all the lows reached over the past decade. We are now approaching that line for 6th time over the past 10 years. In fact, we appear to be right on the line. This may be the line in the sand, or the NASDAQ’s last stand, if you will. The bubble in 1999 and 2000 is very apparent when looking at this chart. It is amazing that despite a 60% collapse we are still on the long term upward trendline. This chart provides hope that we are likely at an important low and could see an unusually pronounced bounce from this level.

The 5 year arithmetic chart below shows a similar situation and provides additional evidence that the NASDAQ is at a very critical support level.

In my discretionary account, I took a large position in the NASDAQ 100 Index Trust (AMEX: QQQ; 45 1/2) on March 9. Incidentally, the QQQ breached $120 a year ago and represents 100 large cap NASDAQ stocks including names such as Microsoft, Dell Computer and Applied Materials. There are no guarantees the QQQs won’t drop below 45. If they do, we could be poised for a decline that vies as one of the worst bear markets of all time. By any measure this is already a disaster. Who would have believed that a perceived quality name such as Cisco Systems would collapse from $82 a share to $20, or that Yahoo! could be had for less than $20 a share when it was trading for over $200? Anyone who suggested such an outcome a year ago would have been labeled a nutcase, but here we are. These stocks can’t even be called bargains in a traditional sense, in spite of their decline, due to the above average P/E ratios they still command. However, as economies worldwide slowly recover, demand for technology will develop again to absorb the excess supply and the long term uptrend in the NASDAQ will probably resume.

I’m willing to bet money on the 2,000 level holding, but a quick recovery is by no means assured. The market has a tendency to punish investors speculating on a turnaround following a crash in a specific sector. Recent collapses that come to mind are the oil sector in the early 80’s and the biotechs in the early 90’s. It took years before investments in those areas paid off following their bear markets. With that caveat in mind, I wouldn’t mortgage the house to gamble on an immediate turnaround in the NASDAQ. However, the relatively quick obsolescence of technology and the need for replacement has allowed tech stocks to recover more quickly from past setbacks than other sectors of the economy. I’m anticipating a bounce of 20% or more from this level in the next 4 to 6 weeks. The risk versus reward at this juncture appears to be unusually favorable. However, only time will tell if my judgment is correct or I end up with egg on my face.

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