Review
On November 29, 2012, in an article titled “Dow Theory: Secular and Cyclical Markets“, we said the following:
“A common timeframe for our version of secular periods averages around 18.8 years based on the previous five periods. This suggests that if the 2000 peak holds then the secular bear market should end in the years between 2016 to 2023.”
On January 1, 2018, in an article titled “Dow 130,000 by 2032”, we said the following:
“This is the first posting for 2018 and we want to be clear about what we see for the market. Dow 130,000 is not specific to 2018 but to the secular market trend that we are in.”
In this article, we outline how the Nasdaq Composite is just getting warmed up.
Questions Remain about the Nasdaq
There is considerable concern about the run-up in the Nasdaq Composite Index. Understandably, the run from the March 23, 2020 low has been meteoric.
Any major index that increases +75.73% in less than a year has got some technical and fundamental reversion to the mean ahead. Applying Dow Theory (which encompasses fundamental, economic, and technical analysis) we arrive at downside targets to consider in the chart above.
How good is any talk of “reversion to the mean” or “Dow Theory” or downside risk considerations? Let’s take the Dow Jones Industrial Average when it was almost at the same levels from the period of March 9, 2009 to the high on March 9, 2012.
Naturally, the indexes are different, the rate of increase is different, the time is different. However, The price levels are essentially the same. Since reasonable market analysis begins with precedent, we believe that what happened to the Dow Jones Industrial Average in 2009-2012 period is a decent starting point for the Nasdaq Composite.
As the ascending lines of the Nasdaq Composite show, as part of Dow Theory, the index has the following downside targets without raising any alarms:
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9,747.21
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9,458.56
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8,592.59
We’ve only added the 9,747.21 level because it is the first target that was achieved in the Dow Jones Industrial Average before the index reversed to the upside “permanently.”
Another concern brought up is the fact that the Nasdaq Composite valuation levels are extremely stretched. This is a legitimate concern. However, as noted below, the current rise in price is not beyond what has occurred for the index in the past. In fact, the current increase is relatively modest in comparison.
Valuations matter, however, the precedent for the actual change in the index, in the five prior periods, noted in the table below based on the chart above, suggests that there is significant opportunity for additional dramatic change going forward.
Finally, there is the issue of secular bear and bull markets. In our January 3, 2018 article titled “Dow 130,000 by 2032”we said the following:
“…this suggests that if the 2000 peak holds then the secular bear market should end in the years between 2016 to 2023.”
By 2018, it was clear to us that the secular bear market had come to an end (as opposed to our call that the cyclical bear market ended on August 23, 2009).
Looking at the Nasdaq Composite from 2000 to 2016, we see a period of 16 years which the index did not exceed the prior peak. According to Dow Theory, this formation is considered a line. According to Dow Theorist Robert Rhea:
“Such a narrow fluctuation, to the experienced student of the averages, may be as significant as a sharp movement in either direction.”
Rhea, Robert. The Dow Theory. Barron’s (1932). page 82.
Looking at the price change of the Nasdaq Composite, it is hardly a “narrow line” when the index goes from 5,046.86 to 1,119.40. This is unless the index range is in question is looked back upon and realized as a narrow range.
When the Dow Jones Industrial Average experienced a similar line, from 1965 to 1982, the index traded in a range from 1000 to 539. Looking back at those levels, compared to the current 28,000, seems laughable to compare. We believe that at some point in the future, we’ll be looking back at the 5,000 on the Nasdaq Composite as a quaint notion.
Why is a “line” so important? Because in the time that passes (16 years) giant tech companies have innovated, generated earnings, and in some cases initiated dividend payments. The wealth generated in the last 16 years has not been accurately reflected in the index. What is currently being seen is the index catching up to the moderate to high level of wealth creation that has occurred since 2000.
Conclusion
When compared to the Dow Jones Industrial Average at the same price levels from 2009 to 2012, the Nasdaq Composite needs to correct but there is more room to run. That is if the comparison between the indexes is appropriate.
When viewed from the year-over-year price activity since the inception of the index, the Nasdaq Composite has had a moderate run.
When looking at the Nasdaq Composite from the 2000 peak to 2016, the period of doldrums and underperformance has to be made up.
All we can do is watch and wait. So far, the market is behaving as expected considering the circumstances being presented to us.
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