If you think

Nasdaq

1500 is bad, brace yourself. We'll see 1150 soon enough.

Last November, Detox

predicted that the Nasdaq Composite Index would hit 1500, a drop of more than 40%. Ten months later, that milestone is in the rearview mirror -- and the outlook for stocks is bleaker than ever. The economy remains unsteady and political risk has rocketed off the charts after a long absence during the boom.

This nasty new world order means that after a

Fed

-inspired rally or two, you can expect the index to drop an additional 25% or so, hitting levels it last saw in 1996.

Of course, that doesn't mean you should avoid tech stocks

en masse

; software firms, with their low debt levels and easy-to-control expenses, are beginning to look attractive, for instance. But in the aftermath of the terrorist attacks, risky sectors like tech look even more dangerous. New risks that barely existed in the '90s have re-entered the investment equation, and will weigh particularly on volatile sectors like tech.

Welfare State

A big source of uncertainty is the government. Higher spending, resulting from defense purchases and industry bailouts, will suck capital away from productivity-enhancing investments.

In about a year, the Bush administration will become strained and divided as it struggles to obtain a clear-cut victory over terrorism, and the president's approval ratings will tank. As a result, political instability of a level not seen since the Carter years will emerge in the U.S., boosting interest rates, weakening the greenback and spooking investors.

Let's start, however, with problems that existed before the carnage of Sept. 11: overvaluation and Alan Greenspan.

Valuing the Nasdaq Composite Index is tough, due to the huge number of stocks and lack of earnings data. Obtaining a

price-to-earnings ratio for the Nasdaq 100 index is much simpler. Detox calculates that the Nasdaq 100 is trading at 73 times 2001 earnings forecast by Thomson Financial/First Call, and 42 times expected 2002 earnings. That's frightfully expensive.

(Note that the Nasdaq 100 is a weighted index. This means some companies' index weights are higher than their market capitalization, and vice versa. If you adjust forecast earnings to bring them into line with index weights, as one should, the 2001 P/E goes up to 103, while 2002's jumps to 52.)

Many have talked about valuations coming down as earnings rebound in 2002. But the 2002 estimates used here already are predicting a rip-roaring recovery. Weighted aggregate Nasdaq 100 earnings are expected to be $25 billion for 2002, nearly double the $13 billion forecast for 2001. (Unweighted earnings are targeted at $18 billion for 2001 and $31 billion for 2002.)

Next, let's be insanely generous and assume that the Nasdaq 100 trade deserves to trade at 40 times those weighted 2002 earnings. That would give the Nasdaq 100 a market cap of $1 trillion, and an index value of 915, 23% below Tuesday's close. Apply the same drop to the Nasdaq Composite index and you get 1155.

Leaking

Now, the Nasdaq may not go straight there. The Fed, under Greenspan, has set the printing presses whizzing in a bid to prop up stocks and sustain economic activity. In the two weeks ended Sept. 19, the Fed added a record $44 billion to the monetary base, according to Bianco Research. Some of that money is bound to leak into equities over the coming months and create short-lived rallies.

Why won't the liquidity-inspired rallies last? Because all the easy money in the world can't create healthy companies and sustainable profits. In fact, the Fed's largesse will only forestall the deep restructuring U.S. firms need. Arguably, a smart time to buy stocks is when a central bank has been hiking interest rates for a while to slow the economy, not when it's reducing them in a panic to stop a recession from ever happening.

That enormous monetary stimulus is likely to be accompanied by increased government spending. Some will chime in that inflationary policies during wartime can be good for equities. Well, explain then, why the

Dow

posted only an average annual return of 0.75% in the 1966-72 period, when the Vietnam War was raging and inflationary pressures were high.

Of course, military spending won't be anywhere near as high as in the Vietnam War. And a government can still lean toward laissez faire economic policies while boosting the defense budget -- look at the Reagan administrations. If hefty tax cuts do get passed, Bush may be able to pull off the same stunt. But the chances of that look remote with the Senate tilted against the presidency.

War, What Is It Good For? Not Stocks
The Dow and inflation during the Vietnam War

Sources: Economagic, Detox, Yahoo! Finance

But disputes over taxation will seem trivial once the Bush presidency starts to buckle under the stress of fighting an unwinnable war. The tasks of wiping out terrorism and bringing those instrumental in the attacks to justice are almost impossible to achieve. The public is baying for the sort of dramatic results that no president could deliver. Failure to secure cut-and-dried military victories in this conflict will cause the rift between hawks and doves in Bush's administration to widen, as they begin to blame each other. The leaking will follow and the press will pile on.

Nosebleed valuations, a profligate monetary policy, higher government spending and infighting in the executive branch. No time to be buying speculative tech stocks.

Know any companies that the market may be misvaluing? Detox would like to hear about them. Please send all feedback to

peavis@thestreet.com.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.