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BEING STREET SMART 

by Sy Harding

How About That Nasdaq? Dec.26, 1999.

We're getting a number of requests to include more information, charts and forecasts on the Nasdaq. It's not easy to provide, as no one, including us, can get much of a handle on this craziest market situation ever seen. 
As we've been saying, fewer than 100 of the 4,500+ Nasdaq stocks have provided more than 90% of the gains in this rally from the October low. 
So to get a handle on what the Nasdaq Composite will do from here it's necessary to figure out whether those stocks will be able to become even more overbought and overvalued. 
The following chart of the Nasdaq clearly shows the problem.

Never in history have the technical indicators been anywhere near as overextended to the upside. Never before has the Nasdaq Composite come close to being spiked up as far above its 200 day moving average without a serious correction resulting. 

Can it continue? It's already proven it can, having continued past where all historical patterns and common sense said it could not. 

So, next we look for reasons why that has happened, to see if it should continue. Is the earnings growth of those 100 stocks so fantastically great that their stock valuations are simply reflecting the earnings growth? 

The answer is clearly no. For instance, according to Value Line; Sun Microsystems, representative of the group, saw earnings grow 42% in 1997, 21% in 1998, 25% in 1999, and Value Line estimates that Sun's earnings will grow 20% in 2000. The stock?  It gained 52% in 1997, 109% in 1998, not really out of line given the earnings growth and the accompanying strong, broad based bull market, led by the tech sector. 

And through 1997 and 1998, as the chart shows, Sun's stock reacted normally as it made those gains, having significant corrections each time it and the indicators became over-extended to the upside.

However, since the low in October of 1998, after which the majority of stocks did not recover, but headed even lower, Sun has spiked up 701%. Just keeping up with earnings growth, or earnings growth projections for next year? Obviously not.
What then? The only explanation is that the stock has gone off on a surge of momentum based trading (traders buying stocks that have been going up for no other reason than that they have been going up, on the hope that they will keep on going up, but ready to bail out the instant the momentum stops). 
So, now the stock is selling at 85 times earnings compared to its average 15 times earnings from 1994 to 1998, and 14 times earnings through the 1990s.

Let's take a look at another representative stock of the 65 stocks accounting for the  Nasdaq's super gain this year, and particularly since the market's low in October, Qualcom. Its earnings were up 52% in 1998, are expected to spike up 179% in 1999, and are estimated to grow 54% in 2000. 

Great earnings growth, but in response the stock  gained 1700% in 1999. The P/E ratio? 200 times earnings.

We've deliberately chosen stocks with good earnings to represent the group of 100, as at least there is earnings growth to analyze as a possible reason for their stock's spike-ups. 

When it comes to the similar spike-up gains in the 30 or so Internet stocks in the group, 95% having no earnings at all, most producing ever larger losses even as their sales grow exponentially, (and as Wall Street analyst Byron Wein recently said, 90% never will have earnings) it's even more impossible to understand.

Meanwhile, the majority of stocks are down for the year (67% of Nasdaq stocks are 20% below their 1998 highs, and 75% of NYSE stocks are below their 200 day moving averages.

We did not like the froth in the Nasdaq in October, and we like it even less now. We'll 'settle for' the double digit gains the Seasonal Timing System is making in the S&P 500. 

Will everyone expecting to exit at the first sign of a reversal of the Nasdaq's upside momentum be able to get out unscathed? Absolutely not. The downside of a parabolic spike-up when it comes, is usually as abrupt as the spike-up.

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