History Lessons: Honing In on the Nasdaq

The drop in the Nasdaq Composite over the past two quarters has been savage. But if you look at its historical context, there's some reason for hope.

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History Lessons: Looking at the S&P

Tuesday I wrote about the horrible six-month period ended last Friday, when the S&P 500 lost 19.23%. It was one of the worst six-month periods in the history of the S&P index and its predecessors since 1800. Out of 2,409 six-month periods, only 77 -- or 3.2% -- have been worse.

But for the Nasdaq, these past six months -- in which the index has lost a mind-numbing 49.90% -- have been the single worst six months in the index's history since 1939. And that's quite a statement because, over the years, the Nasdaq Composite has gone from being a ragtag collection of second-rate stocks that couldn't get listed anywhere else into a prestigious roster of some of the world's largest companies. And yet even now, it has snatched defeat from the jaws of victory.

A Look at the Figures

To keep things comparable to the way we looked at the S&P Tuesday, let's look at the worst 24 of the 744 six-month periods since 1939. (That's the top 3.2% of worst periods.)

Two periods -- the most recent two -- had losses worse than 40%. Four periods were worse than 30%. And all the rest had losses worse than 20%.

The five most recent six-month periods -- those ended in March, February and January of 2001 and in December and November of 2000 -- all made the list of the worst 24 in history, with the latest being the very worst.

As it was with the S&P 500, no six-month period during the 1990s was among the worst. Three from the 1980s made the list, as did eight from the 1970s.

So can it get any worse? Sure it can, and indeed since the end of the quarter last Friday, it's already gotten a lot worse. But on a historical basis, there's some reason to believe that when the Nasdaq's rubber band gets pulled this tight, a snapback can't be too far behind.

Excluding the five most recent six-month periods in history's worst 24, 15 showed gains in the following six months. The average gain was 22.17%. That would hardly put a dent in your losses if you bought the Nasdaq six months ago, but as they say about taking your taxi receipt in New York City, "It can't hurt, and it might help." Not so long ago, a gain like 22.17% was thought of as a whole bull market. And by historical pattern, that could be what the Nasdaq is entitled to over the next six months.

The Good News

What's really encouraging is that there were only four periods in which there were losses in the following six months, and the average loss was 5.19%. Based on Monday's and Tuesday's action, that's already happened -- and then some. That rubber band is feeling mighty tight.

There's another way of looking at it, too. There's reason to believe that if the Nasdaq's excellent adventure to 5000 last year was just a bubble, it's now popped, and we can get back to business as usual.

To see that the Nasdaq's excesses may be now entirely burned off, take a look at this chart of what would have happened if you'd invested $10,000 in the Nasdaq, the S&P 500 and the Dow Jones Industrial Average about five years ago, on March 30, 1996.

Where Your Money's Gone Here's how a hypothetical $10,000 investment would have fared in the major market indices over the past five years.

By the time Alan Greenspan was delivering his famous "irrational exuberance" speech on Dec. 5, 1996, that $10,000 had grown to about $11,500 in the S&P 500 and the Dow, and to about $11,800 in the Nasdaq. But over the next couple of years, the Nasdaq got way out in front. On March 10, 2000, the $10,000 in the Nasdaq had grown to an astonishing $45,838. The investment in the Dow peaked earlier, on Jan. 14, at only $20,982. And the investment in the S&P peaked a few weeks later on March 24, at only $23,663.

But last March, when the Nasdaq first launched into this latest down-leg in its great bear market, the 5-year-old investment in it fell behind the investments in both the S&P 500 and the Dow. And as of last Friday, the investment in the Nasdaq remains in last place: $16,708 vs. $17,976 in the S&P 500 and $17,681 in the Dow.

A Long, Strange Trip

Was this trip really necessary? Good question. But the question that haunts technology investors now is even more important: Will a similar trip take place in the future, but in reverse? Will the Nasdaq now have to underperform the S&P 500 and the Dow for the next several years, with the same extremity with which it outperformed them in the past several years?

Or should we expect that equilibrium has been restored right where we are now, and that there is no reason to expect things to get out of whack in the future simply because they were out of whack in the past?

At this moment, with the bottom falling out of all markets, these long-term questions almost seem quaint. For those of us who hunker in the market bunker every day, we ask a more immediate question: With the rubber band pulled back this tight, doesn't it have to spring back here pretty soon? Or is it just going to snap?