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Chart Advisor | Focus on the Price

Wednesday, February 19, 2020

1. Nasdaq surge may draw new investors

2. Has this happened before?

3. The money trends in play

Market Moves

The market's major indexes edged higher today with both the Nasdaq 100 index (NDX) and the S&P 500 index (SPX) finishing at their highest closes to date. Meanwhile a 23% rise in Virgin Galactic (SPCE) and a 6% rise in Tesla (TSLA) shares have drawn enough attention that some market watchers have felt the need to voice appropriate words of caution.

Such caution is well warranted. There is no question that markets are priced high by historical measures of valuation. But such cautionary statements are impossible to make in a timely matter, no matter how good one's intentions may be. Consider the mystery chart below. This chart shows a price pattern of a well-known stock that increased in value by 600% over a ten-year period. Any guess what it might be?

Has This Happened Before?

The identity of the chart above is not actually a single stock. It is the Nasdaq 100 index during its now infamous rise towards the internet bubble. However, one might have difficulty determining exactly when the bubble part began. Former Fed Chair Alan Greenspan famously quipped that markets were exhibiting "irrational exuberance." That phrase later became the title of a book by Robert J. Shiller, nobel-prize winning economist and creator of the Shiller PE ratio. The primary point of Shiller's book, and the selection of its title, is that investors should show caution when approaching the markets, because it is easy to get caught up in a bubble.

While the sentiment is certainly wise, the timing of Greenspan's statement and the point of Shiller's book seems muddled by how the subsequent two decades played out. Consider that Alan Greenspan made his comments at the end of 1997, roughly the place where the chart above ended. From that point in time, the S&P 500 went on to triple in value in just two years! Even more shocking, when the market crashed not once but twice in the following decade, BOTH times it did not fall significantly below the price level where it was when Greenspan spoke his cautionary phrase. In other words, with the benefit of hindsight, though the markets did eventually rise and fall dangerously, the point at which Greenspan made his comments turns out to be neither irrational nor even exuberant.

Consider the following chart which overlays the Nasdaq 100 in the ten-year period previously shown (1988 to 1998) with the past decade (2010-2020). Though stocks have had a tremendous run recently, they have merely mirrored the 90s. If for some unknown reason, the next two-year period were to play out the same way as the period from 1998 to 2000, stocks would triple in value from this point in time going forward, only to crash all the way back to where they are right now.

Since history never repeats exactly, that scenario is probably unlikely to happen, however, it creates an important perspective for the active chart watcher: don't be too quick to call a top, but be prepared to protect yourself from a rapid change in direction if things go south.

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The Money Trends in Play

It is interesting to contemplate the macroeconomic environment in which the stock market has been able to rise strongly over the last decade and consider whether it can continue to do so. The chart below gives some insight into important trends among money-market investors and their choices over recent years. This chart compares the U.S. Dollar index (DXY) with State Street's Gold price index ETF (GLD), Invesco's Euro currency trust index ETF (FXE) and Invesco's Japanese Yen trust index ETF (FXY).

It is clear to see how the dollar separated from the other three about six years ago, and though the Euro and the Yen have continued lower, Gold has spent the last year moving away from being in concert with them to approaching the price movements of the U.S. Dollar. This may suggest a growing concern with international financial matters, and an overall preference to move towards something considered safe. For this reason, money may have been coming out of international markets and into U.S. stocks over the past year or so. Given the performance of the U.S. benchmark indexes, it seems logical to think that this is a continuing dynamic even now.

The Bottom Line

Stocks moved higher today prompting many to consider the methods by which they will exercise caution. It is difficult to balance the need for caution with the opportunity for exceptional gains, as history shows. Meanwhile the Euro and the Yen continue to fall compared to gold and the U.S. Dollar.