Reversion to the mean. Technology stocks created considerable wealth…and then destroyed it. For a time we all believed the sky was the limit. The Nasdaq soared from 2008 in July 1998 to 5048 in early 2000. On 3-13-01 the Nasdaq was at 2014.In my Strategy Report I have been showing for some time the graphs of the Nasdaq and S&P 500 indexed to 100. The two averages rose at exactly the same pace from 1995 to 1998. At that time the idea of a “new economy” began to find widespread acceptance and the appreciation of the Nasdaq outperformed that of the S&P 500 by soaring 150% in the following two years.
The idea of showing the chart (the updated version can be found on our website www.peterdag.com in the “Thought of the day” page) was to suggest that a reversion to the mean should have been expected, with the Nasdaq falling back to the line of the S&P 500. At that time the Nasdaq would have shown the exact appreciation of the S&P 500 at least since 1955.
The reversion to the mean has been completed just a few days ago. On 3-13-01 the Nasdaq was trading at 2014 and the S&P was at 1197. On 7-17-98 the same two indexes were at 2008 and 1187 respectively, showing no gain since 1998. The bubble has deflated and the Nasdaq has reversed to the mean, showing the same appreciation as the rest of the market (Fig. 1).
What is going to happen next to the Nasdaq? The technology stocks benefited from 1998 to 2000 from the economic bubble created by the excessive money creation of the Fed. The strong economy was the main engine that drove earning growth.
However, when the money supply began to slow down, the economic profile changed. As I correctly predicted, slower growth in the money supply was followed by slower growth in the economy and earnings. The high
PEs of the technology stocks were not justified anymore, and stocks corrected to reflect the more subdued economic conditions.
Wall Street remains fixated with technology stocks and the Nasdaq. The reasons are obvious. But I think that from this point on the action of the Nasdaq will mirror the action of the broad market. The Nasdaq companies cannot deliver high earning growth in an environment of slow economic growth.
George Dagnino, PhD
Editor, The Peter Dag Portfolio. Since 1977
Ranked best market timer in the 12 and 6 months ending 8/20/10 by Timer Digest
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