There are a number of solid reasons why analysts believe the Nasdaq is not in record territory, beyond the fact that, on an inflation-adjusted basis, Nasdaq (NASDAQ:IXIC) would have to break through the 7,000 level to be at record levels and to beat its March 2000 historic high of 5,048, using 2.2% annualized inflation.
Burt White, Chief Investment Officer for LPL Financial, points out other reasons why Nasdaq isn’t yet in bubble land. It has been a heck of a 15-year trek back to these levels, which “included two recessions along the way — one of them 'Great,'" White notes. But “even with the Nasdaq at 5000, based on valuation and sentiment measures, we do not believe stocks have reached bubble territory. As we walk down memory lane to the days when we got stock picks from cab drivers and chat rooms, we see that the Nasdaq’s foundation is much stronger today.”
Gone are the revenue per eyeballs and revenue per clicks metrics that Wall Street used to value dotcom companies, the era of Pets.com and Webvan. Books appear to be cleaner—even though the economy just endured a massive subprime accounting scandal—and Wall Street appears to be tighter in its analysis of companies. As White has done, it’s important to compare where valuation measures stood during the dotcom era and where they stand today. White notes:
- The March 2000 price-to-earnings ratio (PE) of 107, based on then current year estimates, bears no comparison to the latest reading at 25 (as of February 27, 2015).
- The forward PE, based on the following year estimates, tells the same story, with a PE of 75 then and 21 now.
- Underlying these lofty valuations then was a set of Nasdaq companies that was much less profitable. The top 10 holdings today generate nearly five times the earnings of the top 10 as of December 31, 1999 (excluding WorldCom and its cooked books).
White adds that, even when you conduct valuation “based on book value, or the value of company assets minus liabilities,” you’ll see “a much more expensive Nasdaq then versus now." Yes, “operating earnings” stripping out all the bad stuff, was in fashion back then, still in use today. But back in 2000, the Internet bubble was held aloft due to weak valuation measures—besides clicks, eyeballs, page views were in vogue, too, down on Wall Street, since these companies back then had not built out their infrastructure or operations and had no real assets. As a result, “the price-to-book value ratio (market cap divided by book value) at the peak in March 2000 was over 7, compared with 3.9 as of February 27, 2015,” White says.
And even on a cash flow basis, the Nasdaq still looks reasonably valued. “The Nasdaq Composite’s price-to-cash flow ratio (market value divided by operating cash flow generated) approached 100 at the March 2000 peak, compared with roughly 20 currently,” White adds.
The slug of dollars flew fast into technology sector investments back then, a massive momentum play that “pushed the Nasdaq up 189% during the two years leading up to the peak on March 10, 2000, a much steeper ascent than the 57% gain in the index during the past two years,” White notes. “The technology sector represented 35% of the S&P 500 at the Nasdaq’s peak, compared with a current level near the long-term average at about 19%. The Nasdaq had a 57% technology weighting then, versus 43% today.”
Also, based on data from the Investment Company Institute (ICI), net purchases of equity mutual funds by individuals exceeded $25 billion per month at the peak in early 2000, compared with just $6.5 billion during the latest reported month (January 2015), White says, noting that, in fact, “the ICI has reported net outflows to equity mutual funds in aggregate since the financial crisis (2008 – 2014), reflecting a healthy dose of investor skepticism.”
Investor confidence was out of whack back then, too, driving valuations “to unsustainable levels,” White says. “For example, the Conference Board’s reading on consumer confidence peaked at an all-time record high of 145 during January 2000 (data back to 1969), compared with the most recent reading of 96 in February. More caution among consumers is indicative of a much more rational market environment and an absence of the types of excesses that lead to significant stock market downturns.”
And stocks as a percentage of household assets are lower today versus the dotcom era, based on data from the Federal Reserve. “This statistic reached an all-time high during the first quarter of 2000 at 53.6% (data back to 1952), while the most recent reading for the third quarter of 2014 stood at 40.8%,” White says, adding, “the Nasdaq has a much stronger foundation of valuations, profits, and sentiment today. We maintain our positive stock market view for 2015.”
Sentiment Then Versus Now