Relative to the DJIA, the Nasdaq and the S&P are significantly undervalued. If you look at the market and assuming it's not different this time :), bull markets last around 25-27 years and go up 10 times. Bear markets last around 12-13 years or about 1/2 as long as bull markets. The only returns you get during bear markets are dividends as the averages bounce around alot but do not break their highs of the last bull market. Going back to the beginning of the last century, we;ve had 3 bull markets and 2 bear markets. From the early 1900's through 1929 was the first bull market and the DJIA went from 10 to 400 - a far larger bubble than the one we've just experienced in the Nasdaq. For the next 13 years we bounced around until we began the new bull market in 1942 at 100. We went for 27 years to cap out at 1000. From 1969 until 1982 we bounced around and then began the current bull market which should go to 10,000 by somewhere around 2007. We exceeded that goal 8 years earlier. We are currently 50% above where we should be in this bull market. If you apply the same analysis to the S&P 500 and the Nasdaq, we started the bull run at the same time at 130 and 200 respectively. With the Dow, part of the return is in the form of dividends. Actually, just under 10% is capital gain (9.65%) to achieve the 10X goal in 25 years. Return includes dividends of 2%. This is probably conservative. The total return is therefore 11.65%. The S&P does not pay as much in dividends so the capital gain is 10.65% and the Nasdaq pays virtually no dividend so the capital gain is 11.65%. Using these figures, we are 13% over where we should be for the S&P 500 with a goal of 1632 by 2007. With the Nasdaq, we are 8% over where we should be with a goal of 3144 by 2007.
This analsis presents 3 interesting observations. One, we've all heard that stocks go up around 11% (total return) each year over a very long period. This is not true - the return is more like 9-10%. Two, it makes no sense to invest in the Nasdaq or the S&P 500 if their returns are equal to or less than the DJIA. Three, according to accepted market rules, the Nasdaq and S&P 500 should return more than the DJIA due to their higher risk but this does not seem to be the case. Assuming that these indexes (companies within them) are not going out of business, a logical conclusion would be that the DJIA is overvalued (and this is supported by the analysis) and the Nasdaq and S&P 500 are undervalued. This anomoly runs completely counter to current market sentiment including the analysts.
We all know that psychology plays a significant role in market performance so I don't think I'm going to short the DJIA but the current situation presents a very interesting situation. Note the Barrons article this week about the underperformance of the S&P and the Nasdaq relative to the Dow - this is what got me thinking about all this. |
