NASDAQ-100 Bubble Bust Compared To S&P 500 Stocks Index
Stock-Markets / Stock Market Valuations Jan 13, 2010 - 11:06 AM GMTBy: Andrew_Butter
Interesting remark in a recent article by Karl Denninger:
But in 2003 credit was rapidly expanding, as it was in 2004. This is why the S&P expanded back to (and slightly beyond) its previous high - that was all financial leverage. The Nasdaq, made up of companies that made "things" (and services) for the most part, did not recover because it was not able to play financial engineering.
Now credit is contracting strongly ex-government, and even with the government's borrow-and-spend policies total outstanding credit is not expanding at any meaningful pace.
So if the S&P's recovery in the 2000s was based on financial leverage (it was) while the Nasdaq's "recovery" was what you get minus that leverage what happens to the broader indices that are polluted with the "leverage required" firms when the market figures out that the leverage is not coming back?
http://seekingalpha.com/article/181189-western-government-sovereign-debt-in-trouble
I certainly agreed with the first part of that statement which is that the mistake that the Fed made in 2001 was to create a monetary stimulus that helped those that had made bad investments in the build-up to the bubble get off the hook. Following that logic through to it’s conclusion was how I came up (in January 2009) with a prediction for the S&P 500 turn at 675; the idea there was that the bottom in response to the peak in 2001 hadn’t come in properly, but one way or the other, someone had to take their medicine.
But come to think of it, it makes sense that “stimulus” affected the companies that make money out of leverage more than those that, as Karl correctly points out, live by making things (and services) people want to buy, and can’t make a “profit” just by hiring a smarter accountant.
I hadn’t thought of that.
In fact I never thought about the NASDAQ either, so I had a look, this is the chart I came up with:
Background:
Briefly, the Orange Line (OMV) Other-Than-Market-Value is my estimate of what the indexes should have been (left hand scale for the S&P 5-00 and right hand scale for the NASDAQ), if the market was not in what International Valuation Standards and George Soros calls “disequilibrium”.
How I got to that line is I did a valuation using International Valuation Standards.
How you do that is you pick up a copy of the Standards and follow the procedures, it’s a bit like painting by numbers, theoretically two independent valuers ought to get to the same result, although as far as I know I’m the only person who did a valuation of the stock market using IVS.
There are other ways to work out that line; Andrew Smithers uses Tobin’s “q” and Professor Shiller uses P/E ratios, both call the line “Fair Value” (nothing to do with the accountancy definition of Fair Value”). Ben Bernanke has taken to calling it “fundamental value”, although since he claims that he doesn’t have a clue how to work out what it is (I believe him), that’s a bit academic.
The line I get using IVS is different from the line you get using Tobin’s “q” and P/E ratios. Which is right – well who knows?
Personally I like to use a recognised valuation standard whenever I do a valuation (those other methods are not in line with any recognized valuation standard that I ever heard of).
Apart from the fact that I did use IVS, the only other evidence that I can produce to suggest my line is the “right” line, is that based on that line you can get to a logic which (a) in January predicted the turn at 675 (which happened in March) (b) said there would be a strong rally afterwards (there was), and (c) in May it predicted that the DOW would keep on going up at least until it hit 10,000 without a “serious reversal” (it did).
Anyway, that’s the line I use.
Discussion
By that calculation at the peak of the bubble in 2000 the NASDAQ was about 4x OMV and the S&P 500 was about 2x OMV
According to the Seven Immutable Laws of Bubbles that means the bottom of the trough should have come in about ¼ of OMV for the NASDAQ and ½ OMV for the S&P 500.
http://www.marketoracle.co.uk/Article12114.html
That’s about 323 for the NASDAQ (that’s the red dot on the chart) and about 495 for the S&P 500 (that’s the blue dot on the chart).
They didn’t, the NASDAQ turned out losing 50% of what it “should” have lost (according to my calculation) if the Fed hadn’t stepped in and used taxpayer money (current and future), to save the skins of all the malinvestment Ponzi Scheme merchants, and about 20% for the S&P 500.
S&P 500
What happened next was that the S&P 500 (according to my numbers) more or less tracked OMV until 2008, until the house of cards finally came crashing down around everyone’s heads and even the Government of the Most Powerful Nation on Earth was unable to rig the marketplace so that the malinvestments of the past didn’t start to implode, and the 50% of the peak in 2000 came in, like clockwork, exactly as the model predicted.
The moral of that story is that once malinvestments have been made, (thanks to a bubble), you can’t start again until all of those have been washed out of the system.
Funny how Allan Greenspan was happy to stand by whilst the bubble was forming, saying that the “market can look after itself”, and that he couldn’t recognize a bubble even if someone hit him over the head with a copy of International Valuation Standards, but when the whole thing exploded, well he started meddling with the market.
There are TWO things you can do wrong with Bubbles if you are a regulator:
1: Let them happen in the first place (if you know how to do a valuation it’s not hard to recognise them).
2: If you did let them happen, than panic and rush around using taxpayer money (and the money of their grandchildren), to pay off everyone who made a lousy investment and try and sweep the pain under the carpet.
Alan Greenspan made TWO mistakes, not one.
The net result was that a downturn of about seven years whilst the lunacy got “cleaned up”, just got extended to 14 years (i.e. seven years from now is how long this analysis estimates before the S&P 500 will naturally lie at OMV).
That’s why I’m saying that if the S&P 500 comes up to any more than 80% of OMV (right now that’s 80% of 1,500 = 1,250), it’s highly likely there will be a 20% or so reversal (i.e. down to about 1,000).
NASDAQ
To my way of thinking the NASDAQ looks different.
First it got in 50% of where it should have gone (rather than 25% in the case of the S&P 500), second from 2002 to 2008 it bumbled along about 10% to 20% below OMV.
So that’s seven years “on the bench” which is enough time for the malinvestments leading up to 2000 to be shaken out. So for me, it would have been no surprise that in early 2008 the NASDAQ crept up to OMV (I wasn’t actually looking at it but that’s by-the-by).
If (then) I’d been asked to take a bet on what would have happened next I would have said that the NASDAQ was in good shape; and I would have been wrong (I wasn’t asked and I didn’t take the bet).
I’m mulling that over right now. My inclination is to say that the NASDAQ got hit just because the whole market got hit, not because there was a lot of malinvestment or mispricing; like it got hammered unfairly, “in sympathy”.
If that’s right, then the NASDAQ-100 “ought” to creep up to 2,250 to 2,500 in the next year to 18 months, whilst the S&P 500 basically goes (on average) sideways.
That makes some sort of sense, as Karl Denninger was saying, companies on the NASDAQ make things and they provide services, and so they don’t rely half as much on financial tricks and leverage to produce “earnings”.
And until securitization re-starts (unlikely in 2010, and perhaps not even in 2011), anyone who relies on leverage or financial tomfoolery to hit their earnings targets, are going to be left in the dust.
By Andrew Butter
Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.
© 2010 Copyright Andrew Butter- All Rights Reserved
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