Nasdaq 5000 Here We Come

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Don't look now, but the Nasdaq Composite index, which is dominated by technology stocks, recently set a 14-year high, closing March 5 at 4358. But it's the only major U.S. stock index that hasn't established a new record this year. Which makes me wonder: Have investors learned the lessons of the tech bubble too well? Plenty of tech stocks look attractive to me at current levels, and the tech sector is likely to grow robustly in the coming years. But the tech crash early this century was so terrible that many investors still won't touch these stocks.

It's important not to forget how we got here. Everyone knows how crazy investors acted in the late 1990s and early 2000. Many tech stocks traded at triple-digit price-earnings ratios and double-digit price-to-sales ratios. Many Internet start-ups with high-flying stocks had no profits and sometimes no revenues. They were priced based on the number of people who visited their Web sites.


Tech mania was in its fullest flower by the time the Nasdaq index peaked at 5049, on March 10, 2000. The rest, as they say, is history.

Owners of tech shares suffered a two-year battering, during which the Nasdaq Composite plunged 78% before bottoming at 1114 on October 9, 2002. By contrast, Standard & Poor's 500-stock index lost 47% during the 2000-02 bear market. The damage to tech investors' bank accounts and psyches was awesome.

Doug Ramsey, chief investment officer of the Leuthold Group, a Minneapolis-based investment-research firm, has an intriguing theory. He says that after a speculative bubble and subsequent crash, the affected stocks tend to bump along the bottom for years. But at some point they finally regain momentum--and that's the time to hop on board.

Tech stocks bumped along the bottom in 2003, bounced a bit in 2004, then declined again. It wasn't until mid 2009 that tech stocks broke above their 2004 levels, Ramsey says. Twice since then the stocks retreated to their 2004 highs, and both times they rebounded. Those are both bullish signs.

Now, I'm not huge fan of basing decisions on charts and patterns, but Ramsey cites other reasons to buy tech stocks. Among them, relatively low valuations compared with other sectors, and disciplined capital allocation by tech executives--a marked change from the late 1990s. Nowadays, many of these companies are awash in cash.

Just how reasonably priced are these stocks? First, in the interests of full disclosure, Nasdaq is about half tech and telecom; it's not the best tech index. I use it because it's the best-known index. For more precision, let's consider the technology sector of the S&P 500, which holds 65 tech companies, most of them large. You can invest in the sector through the Technology Select Sector SPDR ETF ( XLK ), an exchange-traded fund that charges just 0.16% annually.

Over the past five years through March 14, the tech SPDR returned an annualized 21.3%--about the same as the S&P 500. The sector doesn't look overpriced. It trades at 16imes analysts' estimated earnings for the coming 12 months, and it yields 1.9%The S&P 500 trades at 15 times estimated earnings and yields 2.2%.

What's more, over the past three years, the ETF has exhibited about the same volatility as the S&P as a whole. That's a sea change from the tremendous volatility tech stocks displayed in the 1990s and during their crash.

The ETF is dominated by established companies, not flashy start-ups. Its top holdings are Apple ( AAPL ), Google ( GOOG ), Microsoft ( MSFT ), Verizon Communications ( VZ ), International Business Machines ( IBM ), AT&T ( T ), Oracle ( ORCL ) and Qualcomm ( QCOM ). These are high-quality companies that, for the most part, should thrive for years to come.

What's also reassuring is that you can find tech stocks in the portfolios of top-drawer value funds that shunned them in the late 1990s, such as BBH Core Select ( BBTEX ), FPA Crescent ( FPACX ) and Oakmark ( OAKMX ). (Note that FPA Crescent is a member of the Kiplinger 25 and that BBH is closed to new investors.)

I don't think it will be too long before Nasdaq sets a new record. And this time I expect it to stay above 5000 and continue to grow.One caveat: I'm not talking here about some of the overhyped tech stocks, such as LinkedIn ( LNKD ), Netflix ( NFLX ), Salesforce ( CRM ) and Twitter ( TWTR ), which are every bit as insanely priced as most tech stocks were in the late 1990s.

Steve Goldberg is an investment adviser in the Washington, D.C., area.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Insurance

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