When intelligent investors see media coverage of the Nasdaq Composite’s assault on its bubble-era high, their reaction should be little more than a yawn.
After a stellar showing last year, the Nasdaq is on the precipice of surpassing the 5,000 level and possibly exceeding its all-time high of 5,049 set on March 10, 2000. And if there’s one thing that’s sure to whip the financial media into a frenzy, it’s the prospect of a major index hitting a new high or surpassing a nice, round number.
There’s definitely an element of historical interest involved if the Nasdaq can finally recover from its crash of 2000-01. From the 5,049 high, the index collapsed to a low of 1,114 on Oct. 9, 2002 – a loss of 78%. While the broader U.S. market (as represented by the S&P 500) subsequently touched new highs in 2007 and staged a more meaningful breakout last year, the Nasdaq hasn’t even come close to the levels hit in 2,000 — until now.
For investors, the question is whether a breakout would have any actual meaning.
Unfortunately, the answer is a clear “no.”
First is the simple issue of the number of years that have elapsed since the previous high — a time when stocks were still quoted in fractions. With a 15-year gap, the underlying usefulness of the technical signal is diminished. Technical analysis, after all, is more than just looking at pictures — it’s understanding how the supply and demand at certain price levels are reflected in the charts. After so much time has elapsed, those supply and demand factors are no longer a meaningful factor. Investors should therefore avoid the temptation to use a breakout in the Nasdaq as a meaningful trading signal.
Further, the composition of the index has changed considerably over time. The Nasdaq of 2000 was driven by overvalued dot-com names, many of which are now defunct. Enron and WorldCom were still major players, and Apple Inc. (NASDAQ:AAPL) – then “Apple Computer” — was barely on the radar screen.
In contrast, today’s Nasdaq Composite is driven by a cohort of mature, stable technology stocks. But this isn’t the only difference: Perhaps more important from the standpoint of performance is the current concentration of the index. The top 10 holdings carry a weighting of 32%, and Apple alone is weighted at 10%. This makes the index largely an Apple story, and with the stock already up over 18% year-to-date, it’s little wonder that the index is approaching an all-time high.
There’s also the issue of the composition of the Nasdaq Composite. While the Comp is still shown as the third index in most news reports and trading screens, what is it even telling us at this point? It’s a small subset of the overall market, and the largest companies that drive the index’s performance are already incorporated into the S&P 500. Further, the Nasdaq doesn’t even provide a pure play on any one segment of the market. While reports typically still refer to it as the “tech-heavy Nasdaq Index,” technology stocks only have a weighting of 47%. Consumer discretionary stocks make up 17.6%, while health care account for another 16.6%. In this sense, the index provides little in the way of meaningful signals.
That’s not all. The index is also skewed by what it doesn’t hold: namely, energy and materials stocks. The Nasdaq Composite has a combined weighting of under 2% in the two sectors, which has enabled it to sidestep their substantial underperformance. This has played a large role in the Comp’s assault on its old highs, as well as its recent strength versus other indices.
The relative unimportance of the Nasdaq Composite is underscored by the fact that the one exchange-traded fund that tracks the index, the Fidelity Nasdaq Composite Tracker Stock ETF (ONEQ), has less than $500 million — a relative pittance compared to other index ETFs.
Bottom Line
The Nasdaq moving to new all-time highs would make for splashy headlines, and it would surely be the subject of breathless reporting on cable outlets. However, individual investors — and even traders — should regard such a move as nothing more than background noise.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.
