Nasdaq at 3000: After Long Search for Respect, Finally Getting It

Meet the Nasdaq Composite Index, the market's latest overnight sensation.

Even without this fall's millennial hysteria and the talismanic qualities that condition assigns to large, round numbers, the Nasdaq's breaking through the 3000 level is as good a reason as any to step back for a moment and take stock. Yes, the Nasdaq has come a long way over the last 28 years, and it's time to give the Comp its props.

Nasdaq Hits 3000: Join the discussion on TSC's message boards. The Nasdaq Stock Market's road to respectability certainly has been trod slowly. For years after its inception in 1971, it was known as a backwater refuge for companies unable to meet the more stringent listing requirements of the New York Stock Exchange. And that reputation persisted for a long time, as the Nasdaq's ability to attract top-tier firms was long hampered by blue-sky laws that, until the mid- to late 1980s, required Nasdaq issues to submit to lengthy registration processes from which NYSE and American Stock Exchange securities were exempt.

The question of legitimacy lingered long after states started granting Nasdaq companies blue-sky exemptions in 1984. Debacles like the mid-1990s trading-abuses scandals among NASD broker/dealers or market makers' infamous abandonment of their posts during the 1987 crash still come to mind.

Nasdaq Through the Years
Date	Event
Feb. 8, 1971	Trading begins on the National Association of Securities Dealers Automated Quotation System, or Nasdaq.
Oct. 13, 1971	Intel goes public.
1982	Nasdaq introduces the National Market System, predecessor of today's Nasdaq National Market.
Dec. 6, 1984	Nasdaq receives its first blue-sky exemption, in Georgia.
March 13, 1986	Microsoft goes public.
1990	OTC Bulletin Board created.
1994	Nasdaq surpasses the New York Stock Exchange in annual share volume.
October- November 1994	The Justice Department and the Securities and Exchange Commission launch price-fixing probes of Nasdaq dealers.
July 17, 1995	Nasdaq Comp's first close above 1000.
August 1996	The NASD settles with the SEC, agreeing to spend $100 million to prevent Nasdaq abuses.
April 9, 1998	The NASD and American Stock Exchange boards approve the Nasdaq-Amex merger.
July 16, 1998	Nasdaq Comp's first close above 2000.
Nov. 1, 1999	Microsoft and Intel enter the Dow Jones Industrial Average.
Nov. 3, 1999	Nasdaq Comp's first close above 3000.

Things have changed a bit since then. "That was many, many years ago," says Stanley Nabi, chief investment officer at DLJ Investment Management, who's been around Wall Street long enough to know a blue-chip from shinola. "It may shock you to know that about 20 years ago, American Express (AXP) was over the counter. Weyerhaeuser (WY) used to be over the counter. Time Inc. [now part of Time Warner (TWX)] used to be over the counter in my younger days. Many, many legitimate companies, even in those days, used to be over the counter.

"Today the Nasdaq still has some of these flaky companies, but it has full legitimacy. And sooner or later we'll have a situation where all of these markets will be consolidated, in five or six years."

The pressure that upstart electronic communications networks, or ECNs, have recently placed on both major exchanges gives that argument some purchase. But you needn't look to the future to see the electronic market's ascendancy. Just glance at a few of the Nasdaq's high-profile, large-cap growth components. Without making the hitherto inevitable move to the Big Board, that group has managed to become as much a metonym for "the market" as the Dow Jones Industrial Average itself. Dow Jones (DJ) formally acknowledged as much when it finally admitted the two largest Nasdaq components, Microsoft (MSFT) and Intel (INTC), into the DJIA fold this week.

"You can talk about the vast, unwashed masses below" the big-cap techs, says Richard Dickson, technical analyst at Scott & Stringfellow in Richmond, Va. "But when you're talking about what's been driving the market for the past couple years, it's been Nasdaq stocks. Not New York stocks. It's hard to ignore, and that's proven by the fact that the Dow just stopped ignoring it."

It would take ostrich-like cunning to argue otherwise. The Nasdaq Composite Index is up about 120% since 1997, making the returns of 54% on the Dow and 71% on the S&P 500 seem relatively ordinary. That outperformance is hardly a recent phenomenon. Since 1990, the Nasdaq is up a formidable 554% compared with 300% for the Dow and 296% for the S&P 500.

Two-Tiered Market, Two-Tiered Index

What do you get when you subtract the largest 100 nonfinancial companies from the Nasdaq? About 4,745 other companies.

"It's too complicated for a mere mortal to even fathom what's in the Nasdaq Composite," says Thomas McManus, equity portfolio strategist at Banc of America Securities. "I like to be able to look at a list of companies and realize what's included. I can do that with the Dow and the Nasdaq 100 and even the Standard & Poor's [500]. Once you start getting up there around 3,000 companies, with many additions and deletions every day, it's just difficult to comprehend the size."

Much less certain than the Nasdaq's legitimacy as an exchange, then, is its utility as an index, and not merely because of its unwieldy size. The Nasdaq also suffers from an especially virulent manifestation of the broad phenomenon of the two-tiered market. Over the years, the Comp's intense run-up has been powered by an extremely narrow group of stocks. Five stocks -- Microsoft, Intel, Cisco (CSCO), Dell (DELL) and MCI WorldCom (WCOM) -- account for more than 30% of the Nasdaq's market capitalization.

That kind of skewed representation can be a bit misleading, to say the least.

Nasdaq ex the NDX? Use your imagination ...

Source: Baseline

"Many, many years ago," says McManus, "Standard & Poor's used to publish some of its industry indices excluding some of their largest components, because people complained that you couldn't get a sense of what other components were doing because they were obscured by the movement of larger ones. The Composite ex the NDX -- it would be complicated to track, but I'm sure it would give you a dramatically different picture."

A dramatically different picture, indeed -- if only you had the time to do the math. But then you'd miss the Comp 3K party.

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