March 2005 –

For the Nasdaq, What Next?
   Fifteen Months of Getting it Right?

"Traders get exhausted," notes hedge fund manager James Altucher in his 2004 book, "Trade Like a Hedge Fund."  His comment refers to time periods of a week or so.  Markets often reverse after four consecutive days of either buying or selling (and also on Wednesdays), he says.  Collectively, traders tend to get tired of going one way and they go the other.

I believe longer-term investors, at least in tech stocks, get exhausted too, but in cycles of approximately 15 months.  And it's not mere buying or selling that wears them out.  Their tides turn in alternating stretches of what I call "getting it right" and "getting it wrong."  Those labels compare what the market is doing to what it "should be" doing.

Should be? Here's what I mean. This model applies to the Nasdaq Composite Index, which I believe has followed an interesting pattern of 15-month cycles since January 1999.  Actually, the fifth of five cycles to date will end soon, if my model is correct, and more importantly, Period 6 will bring a change in market behavior.

On Monday, January 4, 1999, the Nasdaq opened at 2207.54. (Heretofore I will dispense with the decimals, and daily index values will refer to the day’s closing price unless otherwise stated.) That’s a notably higher value than at this writing on March 1, 2005, when the Nasdaq opened at 2057.  I contend that 2207 represented "fair value" at that time, continuing a straight, steady uptrend that had been in progress for at least a decade.

The start of year 1999, you’ll recall, was when the tech stock market began to go crazy.  In next 15 months, the Nasdaq Comp did what should have taken 15 years. That is, it rose 132 percent, peaking at an insane intraday high of 5132 on March 10, 2000.  A gain of that size, divided into 15 equal gain periods compounded sequentially, translates to a rise of about 6 percent per period (or 5.79 percent, to be more exact).

Normally, through most of the 20^th century, a 5.79 percent gain in the stock market would take what, a year or so?  So a 132 percent gain should have taken 15 years. Interestingly, however, the Nasdaq’s average annual ascent in the 20 years since 1985—accounting even for the three consecutive big losers following 1999—has been a much higher 11.5 percent. But for this discussion, let’s be conservative and say that since 1999, the ongoing fair value of the Nasdaq index has been its 1999 opening value plus annual increases of 5.79 percent.

The unjustified ascent of the Nasdaq from January 1999 to March 2000 perfectly illustrates what I call “15 months of getting it wrong.”  Let us heretofore refer to that segment of history as Period 1.

After its March 10 top, the market started a slide that lasted to the fateful day of September 11, 2001 and then a couple of weeks beyond, hitting bottom on September 27.  What was most interesting, however, occurred several months before the terrorist attack.  On its way down, the index briefly dipped below 2000 on March 12, 2001, nearly the first anniversary of the top. It stayed in that neighborhood for a month or so, then recovered and reached a near-term intraday high of 2328 on May 22. 

That date, May 22, 2001, marked the passage of approximately 15 months (okay, again 14½) since the top in March 2000.  And that price, 2328, pretty closely represented fair value for that date. That is, if the market had been rising at a "normal" annual rate of 5.79 percent since the open on January 4, 1999, where would it be on May 22, 2001?  I calculate the exact figure to be 2385.

Hence, the stretch from early March 2000 to late May 2001 constitutes Period 2, in which the Nasdaq did what I call "getting it right." The market was overvalued and it sold off.  In roughly 15 months, it fell to the proper level.  The world was in sync—briefly.

What happened next market-long investors should never happen to anybody.  In roughly (you guessed it) 15 months beginning right after May 22, 2001, people got it wrong, and again, very wrong.  Period 3 began with some gradual erosion, as the Nasdaq drifted farther below fair value, which by that time was around 2400.  Through July 2001, the index bounced repeatedly off a glass floor around the 2000 mark.  Then the floor disappeared.  A sickening slide in early August became an avalanche by late August, as the index fell below 1800. I remember the period well, feeling frustrated by the market's seemingly undeserved fate, which continued into September.

In each of the two trading sessions immediately before September 11, the Nasdaq closed below 1700 (a level not seen since 1998).  When the attack on the World Trade Center occurred, I was as horrified, bewildered, and angry as anyone. But was I the only one who also felt a tiny tinge of relief? I pondered, "Is that what's been going on in the market?"  Did the long-planned attack explain the otherwise inexplicable market pounding that preceded September 11? Which raises other questions about who knew what, and when. Good questions, but for another essay.

(Continued on next page)