The NASDAQ Composite Flirts with 5,000
The NASDAQ Composite finally reclaimed the 5,000 mark, which it had previously surpassed for only two days in its history.
On March 9th of 2000, the NASDAQ closed above 5,000 for the first time, reaching a high of 5132.52 before closing March 10th at 5048.62. The subsequent dot-com crash disproportionately crushed the index because of its high concentration of tech stocks. By October 2002, the NASDAQ had lost over three-quarters of its peak value.
Lately NASDAQ has been on a roll, finishing up 7.1% for the month of February and an almost 15% rise over the last 12-month period. A fair amount of the rise is due to Apple (NASDAQ:AAPL) – their stock has risen slightly over 70% since the end of last February and 8.3% over the last month. Nevertheless, the rise in NASDAQ has been relatively broad across the companies.
As the NASDAQ passes 5,000 again, investors are asking themselves: Are things different this time, or is it headed for another precipitous fall?
A Different Composition
While the NASDAQ is still heavy on technology stocks, the ratio of sectors is quite different between March 2000 and now. Technology stocks composed 64.9% of the index in 2000 compared to 43.3% today. Consumer services and health care have a much larger role today, with 20.8% and 16.1% percentages respectively compared to 7.7% and 6.8% in 2000. Telecom has almost completely disappeared – at 0.8% now compared to 11.8% in 2000.
If there is a potential parallel to 2000, it may be in biotech. Renaissance Capital notes that close to one-third of all initial public offerings (IPOs) in 2014 were in the biotech field, with almost half of those focused on important early stage preclinical trials. Many are researching drugs for cancer treatment. Logic suggests that some percentage of them must fail, but there seems to be a more tangible assessment of risks compared to the overly optimistic dot-com field of 2000.
Overvalued But Still Attractive
The NASDAQ may be somewhat overvalued, as many analysts believe. PEG ratios of the NASDAQ 100, the largest 100 non-financial companies, are approaching 3 (1 or below is considered a bargain) and the trailing P/E ratio is relatively high at 22.45. However, these numbers do not seem to be scaring away many investors.
Currently, venture capital money has been pouring into the biotechs. According to Morningstar, the combined net cash input to six biotech mutual funds topped $1.4 billion last year, as compared to 50 tech mutual funds that collectively drew in just over $1 billion.
Interest rates were relatively low during the dot-com boom, encouraging greater investment – but they were more than double today’s historically low rates. In 2000, the effective Federal funds rate was hovering around 6%. It has been at historically low levels (below 0.25%) since early 2009.
Once again, the NASDAQ has crossed the 5,000 mark. Whether any dips will take it below 5,000 again is another matter.
There is almost certain to be some sort of adjustment to the NASDAQ once interest rates rise – perhaps not a full-blown 10% or more correction, but a significant adjustment nevertheless. However, the index is a different animal than it was in 2000. The index is more diversified, and while there is arguably some overvaluation, it is more spread out among various companies and industries. Larger, more stable companies such as Apple balance biotech’s risks.
The overheated dot.com environment had an extreme “growth over profits” attitude, with venture capital pouring into unproven dot-coms with shaky assumptions on their eventual path to profitability. Short-term revenues and earnings were insufficient at best or nonexistent at worst.
The answer is: Yes, in our opinion, it is different this time. The situation isn’t all sunshine and roses, but a repeat of the massive dot-com crash is not likely. We lack the “irrational exuberance” of the dot.com bubble and appear to be in a period of relatively mild overvaluation, which will probably require a relatively mild downward adjustment.
According to the Total Returns page at NASDAQ.com, the NASDAQ Composite index returned 14.75% over one year and over 121% over 5 years. Unless you need to cash out within the next few years, it may serve you well to stick with your investing strategy even through any dip in the NASDAQ. Of course, you should review your portfolio for any individual losing stocks and replace them with something in the proper risk range to meet your needs, regardless of the exchange.