We recently witnessed a historic moment in the world of finance; the NASDAQ closed at above 5,000 for the first time in almost 15 years.
Beginning in the mid-1990s the index rose dramatically, peaking in March 2000 at 5,132, a mere 2.4 percent higher than the 5,008 close on Monday, March 2 of this year.
Any time such a notable milestone is passed, inevitable questions arise. Does this symbolic level suggest that history is doomed to repeat itself? Are the stocks in the index overvalued putting us at risk for another stock market crash? While major retrenching in equity markets is always a possibility, there are a few key differences between the situation today and that of 15 years ago that are worthy of note.
One of the most important changes since the prior NASDAQ peak is that the technology companies driving growth today are more mature. From 1998 through early 2000, the Internet sector burst upon the scene, with stocks of fledgling firms in the segment earning greater than 1,000 percent returns. This time period is often called the dot-com bubble due to the founding and rapid stock price escalation of many new Internet-based companies. Immediately after the peak in March 2000, this speculative market, heavily dominated by the prices of high-technology stocks in the Internet sector and other related fields, collapsed. In the late 1990s, many online companies attained large valuations despite posting no profit and frequently practically no revenue. There was no substance behind a lot of these firms, and the companies did not have enough cash to weather a storm. When the dot-com bubble burst, things went from bad to worse in a hurry.
Another key difference is the near fanaticism at the time of investors. During the dot-com boom, many believed that the market was undergoing a paradigm shift with development of electronic commerce. This enthusiastic belief manifested itself in a speculative bubble as companies jumped on the Internet bandwagon despite the absence of profits and sales. Although in the long run, technology stocks have often proven to be lucrative, an unsustainable situation emerged from the euphoria. In fact, at one point during the bubble, the NASDAQ composite was valued at over 100 times forward earnings, five times larger than its price-to-earnings ratio of 20 today.
Several companies exemplify the difference between the speculative valuations of 15 years ago and the current valuations. The most valuable company in the index in March 2000, Microsoft, currently has a market value of about $360 billion, but in 2000, it was valued at $525 billion. Intel and Cisco also have market capitalization figures that are dramatically lower now than at the peak of 2000. Cisco’s valuation was $466 billion in 2000 and is now $151 billion, while Intel was valued at $401 billion and is now valued at $157 billion. These data highlight the fact that current valuations are less based on speculation and more based on reality.
Additionally, the index composition has diversified since 2000 and the NASDAQ is now comprised of only 40 percent technology companies as opposed to the 66 percent of 2000. Currently, the NASDAQ includes companies like Apple, Microsoft, Google, and Intel among others – all of which are well-established, large cap companies with large cash reserves and real earnings unlike the ephemeral startup companies of the 1990s. In fact, Apple (which accounts for 10 percent of the NASDAQ index) is showing particular financial strength this year, posting a U.S. quarterly profit of $18 billion.
The recent rise in the NASDAQ index is driven primarily by robust earnings and favorable profit forecasts for the technology sector and a greater diversification of global companies. Although this pattern does not mean that a bubble will not form at some point in the future, it does mean that investors should not fear the recent landmark high. This one has all the hallmarks of being generally sustainable.