December 14, 2017 05:17 am CST
Finally: New Highs for Nasdaq
By Geoffrey Pike, Wealth Daily

The NASDAQ stock market index (“Nasdaq”) quietly closed at new all-time highs last week. It is the first time it beat its high closing of 5,048.62, set on March 10, 2000. It is surprising how little attention this news received.

It took “only” a little over 15 years to beat its old record. But a little context is important...

The Nasdaq was the face of the stock bubble of the late 1990s, which began to implode in March 2000. While all U.S. stock indices were booming, the Nasdaq was going parabolic. You could pick virtually any technology stock, and it was almost guaranteed to go up. Almost everyone investing in tech stocks looked like a genius... before the bubble burst.

When the bubble finally came crashing down, it really crashed. Even people who lived through it as adults forget just how bad it was. The Nasdaq hit a low of just over 1,100 in 2002, which meant a drop of nearly 80% over the course of two and a half years.

When the Nasdaq hit its low point in October 2002, it had not been that low for six years. In other words, it took away all of the boom years from 1996 on.

To be sure, both the highs and lows were highly exaggerated. While the high was obviously a massive bubble, the low too was probably a major overcorrection at the time. The euphoria did not take long to turn into absolute fear.

There was also a big drop in 2008 and early 2009, but it quickly reversed. And while the drop was big, it was nothing close to what had happened six to eight years earlier.

When the Nasdaq hit its low point in late 2002, I wondered whether we would ever see the 5,000 level again for the next several decades. While 15 years is still a long time, it is actually quite amazing the Nasdaq has gotten back to these levels considering how out of favor tech stocks were less than 13 years ago.

Japan and China

If you invested your money at the stock market high in March 2000, then you are just now breaking even.

Of course, you are actually way down because of price inflation. You are also down in the opportunity costs of not having put the money somewhere else that would have actually been profitable.

On the other hand, if you had invested in the Nasdaq in late 2002 when it was about 1,200, you would have more than quadrupled your initial investment at this point. Over the course of 13 years, most people would gladly take gain of a 300% or more.

It is rare that anyone buys exactly when a market hits its peak or its low. The same goes for selling. And for those unfortunate enough to buy at the Nasdaq peak, let’s hope they did not sell at the low point.

Believe it or not, there are worse investments out there than the Nasdaq. Take a look at Japan’s stock market since 1989.

If someone had invested in the Japanese stock market at its high point in 1989, they would still be down by almost half, and that is after a period of over 25 years. For those buy-and-hold investors, just how long are they supposed to hold? Perhaps 50 years?

Japan’s monetary policy, at least up until last year, has been much more mild than in the U.S. There was little price inflation in Japan throughout the 1990s and 2000s, so it is not completely fair to compare the nominal gains and losses of the Nasdaq with the Nikkei.

Then there is China. The Shanghai Composite stock index is hitting new all-time highs. It is currently at about 4,500, while it was around 2,500 last November. It is truly parabolic right now.

The Chinese stock market is acting like the Nasdaq did in 1999. Perhaps Chinese stocks are close to March 2000 when comparing to the Nasdaq. But we shouldn’t bet the farm on that. Bubbles can last longer than we think possible, especially with the mania of a large group of people. China certainly has both mania and people.

It is astounding that the Chinese real estate market has been able to hold on as long as it has up to this point. Instead of seeing a busted real estate market there, we are seeing a stock frenzy joining the real estate frenzy.

In the U.S., at least we tend to get one big bubble at a time (although some would say we had both a stock and housing bubble in 2006).

Monetary Policy

The big factor in all of this is monetary policy. It is difficult to imagine a world without monetary inflation because we have lived in a world of central banking for a century. However, we have to recognize the importance of monetary inflation in driving stock prices.

In a world with no monetary inflation, what would stocks look like? Individual stocks would go up and down depending on company profits and their outlook. But overall, stock indices would likely be relatively flat. People would hold stocks for the old-fashioned reason of collecting dividends. If you pick individual stocks, you could still get capital gains if you pick strong and growing companies.

The point is, monetary inflation has a huge effect on stock prices. We sometimes forget that stocks have a price like almost everything else. They don’t get included in the consumer price index, but a large money supply will tend to drive up prices, including stocks.

When money is created out of thin air by the Fed (or any other central bank), it does not flow into the economy evenly. Prices do not go up in tandem. Some prices go up faster than others, and wages tend to lag behind.

New money injected into the economy will find hot spots. These turn into bubbles. China’s loose monetary policy led to a real estate bubble. Now the money is flowing into stocks.

In the U.S., money went into stocks in the late 1990s, particularly in tech stocks. When that popped, the loose money and low interest rates drove new investment into housing, which later popped as well.

What About Now?

Since the fall of 2008, the Fed has increased the monetary base approximately five-fold.

While much of this new money went into bank reserves and was not used for lending, it still has a significant impact. Consumer prices have been relatively tame. Stock prices have skyrocketed over the last six years from their lows in 2009.

While interest rates have continued to stay low, the Fed has maintained a tight monetary stance for the last six months since it ended quantitative easing. But with all of the previous money creation, we have to believe that it caused severe resource misallocations. We have to believe this new money did not flow into the economy evenly, as it never does.

In other words, there have to be hot spots. One hot spot was oil, and that has already crashed down. Real estate has gone back up, but still not to the same levels as the peak of the housing boom, with the exception of a few areas.

So you have to ask yourself: Are there any other hot spots from the Fed’s loose monetary policy?

For me, the obvious place to look is stocks.

We can’t be certain U.S. stocks, including the Nasdaq index, are in a bubble, but that is the way things are looking. The first quarter GDP just came in at 0.2%. The U.S. economy is not exactly booming. Yet stocks seem to be continually flirting with new all-time highs.

The hardest thing about bubbles is that the timing of the bust is almost impossible to predict. A few people were talking about a tech bubble in 1998, yet they hadn’t even seen the parabolic rise at that point. A few were talking about a housing bubble in 2004, yet they were still a few years away from a peak.

The Nasdaq just reached the level it had reached in 2000 when it was at the peak of a mania. Perhaps the Nasdaq will continue its run higher. But you may not want to have too many of your eggs in this basket, because there are significant risks at this point.

Nasdaq 2015 may be the equivalent of Nasdaq 1998 or 1999. China 2015 is probably closer to Nasdaq 2000.

Until next time,

Geoffrey Pike for Wealth Daily

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