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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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NASDAQ 1929 Bears On

Once upon a time, in a great northern forest far, far away, there was a little village.

Humans being humans, this cozy hamlet deep in the forest was not unlike our own society today. Generations lived in the idyllic little village and happily went about their business, continuing the comfortable rhythms of life developed over centuries.

Some of the villagers were very old and wise, having lived a long time and witnessed a great deal of life. These wisemen often met at the local watering hole, stoked a roaring fire in the hearth, grabbed mighty flagons of ale, and with legendary enthusiasm told colorful stories well into the wee hours.

The younger folks sometimes gathered to listen to the yarns of the village elders, but their attention spans were short. The elders often seemed to talk about distant past events that had no relevance to the modern world. The vast majority of the younger generation believed that most of the thrilling tales the elders skillfully weaved were little more than fiction, great entertainment but useless in the far different present-day environment.

One recurring theme that seemed to periodically capture center stage was the warning of the Great Bear. Their weathered and wrinkled faces lit by firelight and their cheeks flushed from the perpetually flowing ale, the elders' eyes twinkled like stars as they passionately told tales dredged up from long ago in history. They recounted the almost forgotten days of their own youth, when a Great Bear came to terrorize the village. The bear stories were always graphic and a bit frightening, and to the youngsters it seemed almost impossible to believe that such fantastic events truly happened.

Sure, occasional bears were still seen in the great northern forest by the village hunters, but these were rather anemic sized and were certainly no threat to armed men. It had been three generations since a Great Bear roared onto the scene and few remembered except the elders.

One winter day a band of the village's best and bravest young men went hunting. They carried their full arsenal of weaponry, including the relatively new innovations of rifles, and they felt they were invincible. They had never met a bear, moose, or any creature that they couldn't take down to use for food and supplies. Surely, they reasoned, if Great Bears really existed they would not be as fearsome today in the face of all the wondrous modern hunting tools. The elders, assuming they weren't just fabricating the Great Bear legends, only had spears to do battle with the mega-bears.

As they trudged through the snowy forest in search of prey, a great roar shattered their peaceful hike. None of the men had ever heard such a mighty bellow before, so they decided to cautiously investigate. After all, they had modern rifles and had been hunting in the great northern forest their entire lives. They feared nothing.

After an hour of stealthy passage the men finally reached a clearing, and in the middle lumbered the biggest baddest bear any of them had ever seen. It looked many times larger than the normal bears they knew, and black fear started to fill the men's hearts. Amazingly, the Great Bear hadn't yet detected them as the snow and wind dampened their approach.

Most of the men wanted to turn back and get the heck out of dodge, they were terrified. But, the bravest of the hunters whispered that they should stay and slay the Great Bear. He rallied them by filling their heads with epic visions of heroic adoration from the village and legendary profits from selling the bear's one-of-a-kind pelt. The hunters semi-reluctantly agreed to all fire their rifles simultaneously, betting that they could cast enough lead down range to stop the Great Bear.

A startling salvo of shots rang out and thundered through the woods. The Great Bear was hit dozens of times by the skilled hunters, but the bullets seemed like mere bee stings to the mighty beast. It let out a bloodcurdling roar and charged. Presumably, no one escaped its insatiable wrath and fury as no trace was ever seen of the brave hunters again.

Today's NASDAQ investors are a lot like that doomed band of young hunters!

Sure, NASDAQ investors have heard the stories of supercycle Great Bear markets from the market elders, but they have never seen one with their own eyes and don't believe one could transpire today. Today's bold NASDAQ investors, like the young hunters, have haughtily spat upon the accumulated wisdom and advice of the ages about real bear markets. Armed with the wondrous new tools of the Information Age, the NASDAQ investors feel invincible and truly believe they are the Masters of the Financial Universe.

Unfortunately, just like the hunters in our fable, today's NASDAQ investors are so arrogant that most still don't have a clue that they are inexorably marching over a cliff to their doom like naïve lemmings. The Great Bear markets the elders discuss really do exist, and enormous mountains of evidence continue to accumulate suggesting that the market events of the past couple years are something unlike anything else witnessed in the United States since the 1930s.

In this essay we will take a look at the latest iteration of our infamous comparison between two Great Bears, the NASDAQ action of today versus the Dow Jones Industrial Average action during those dark days of the legendary 1930s. Both markets were the very nexus of speculative excess in their respective bubbles and both markets mercilessly captured and slaughtered the capital of virtually an entire investing generation.

I originally discussed this comparison way back in August 2000 in "To Crash or Not To Crash" when the NASDAQ was trading above 4000. We evolved the graph and updated our analysis in December 2001 in "NASDAQ 1929", when the NASDAQ was trading near 2000. Today, as we unleash our latest iteration of this morbid yet fascinating ongoing research, the NASDAQ is struggling around 1500. The Great Bear carnage rages all around us!

Here is the previous iteration of our Great Bear comparison stuffed full of current data. For all you technical chartists out there, this comparison is exceedingly simple to create. The March 10th, 2000 NASDAQ bubble top of 5049 is matched exactly with the September 3rd, 1929 DJIA bubble top of 381 and the data is then run forward on a one-to-one trading day basis.

NASDAQ 2000 vs. DJIA 1929

Bears of a feather… you know the old proverb! The distressing NASDAQ bust action of today is practically a spitting image of the DJIA action during the Great Crash and early Great Depression. While short-term tactical dissimilarities abound, the overall strategic picture drawn by these two Great Bears is virtually identical. Great Bears don't mess around and they maul capital and slaughter speculative excess with frightening efficiency!

I have received countless wonderful personal letters from investors around the world since our NASDAQ 1929 graph was first published.  They graciously tell me that they saw the graph which led them to do some serious research of their own. Then they understood that the NASDAQ was in serious trouble, liquidated their high-risk tech darlings, and are now hundreds of thousands of dollars ahead compared to if they would have followed Wall Street's advice and rode the NASDAQ bust down to the pavement. It is a huge blessing to know that one simple graph can have such an important impact on so many folks' lives and financial futures!

Alas though, as much as we like this graph, the time has arrived to change it.

A few market technicians recently wrote to me and told me that the graph was giving them problems. They were printing out the graph, measuring the two data series, and trying to use the DJIA 1929 episode to define a probable time frame for the ultimate NASDAQ bottom. A problem arose though as the two data series didn't appear to match up well enough over the whole 66-month time span of the graph.

The NASDAQ series seemed to be running a bit slower than the DJIA series for some reason, and near the end of the right side of the graph the absolute time frame of NASDAQ 2000 and DJIA 1929 increasingly looked like they would ultimately come in more than nine months out of phase. The problem was strange and perplexing.

Our business at Zeal is painstakingly built on honor, integrity, and trust so I needed to find out what the problem was and rectify it immediately. We downloaded brand new fresh data for both series and rebuilt the graph from scratch to see if the same thing happened. Interestingly, with new DJIA 1929 and NASDAQ 2000 data, the perceived distortion ratcheted down considerably, to the single month range at the end of the graph.

The latest iteration of our NASDAQ 1929 graph, shown below, is based on this brand new data from a world-class commercial data service provider and is more accurate. Thankfully the overall strategic picture and implications of the graph are completely unchanged, but tactically for timing the technicians should find this version easier to use as the DJIA 1929 and NASDAQ 2000 total time periods elapsed at the end of the graph should be much closer.

What was the problem? Bad DJIA 1929 data!

In early 2000, soon after I founded Zeal LLC but months before I started writing publicly, I was spending a lot of time playing with data. I was convinced the NASDAQ was a bubble based on its extreme valuations and parabolic nature, but before the March 2000 top I had no way to prove how dangerous it was. I sought out historical bubble data, including DJIA 1929 and Japanese Nikkei 225 1989 data, to compare with the unfolding NASDAQ situation.

In the early days before Zeal had any cashflow, I sought out low-cost data so I would not have to dip into my own hard-earned savings and investments before the Zeal concept proved to be a valid business model. I did some web searching and found a doctoral student at an Ivy-League American university who was selling data on the side. He had a professional-looking website and apparently was doing pretty good business as a merchant of data. I purchased my DJIA 1929 data series from this gentleman.

Looking back now more than two years later, it all reminds me of a street vendor in Tijuana, Mexico. "Hey Meeeeester! Wanna buy some data? It's real cheap! I give you gooood deal on 'dis very nice data." I paid the man, who is now a Ph.D. and no longer a data merchant, downloaded my shiny new data, and was off to the races.

The first thing I did was blasted the data into Excel, graphed it, and laser printed an 8.5" x 11" graph to see how the data looked. I spent an hour comparing my freshly-printed graph with historic DJIA graphs in several books, painstakingly comparing peaks and troughs, and it looked identical. I was good to go!

While the data worked great for single-series graphs, it had a problem that rendered it distorted for comparisons. Upon closer examination two weeks ago after the technicians' e-mails, I found that the DJIA 1929 data had irregularities. For each month of daily closing data, sometimes two or three closes were for historical dates happening to fall on Saturdays! Saturdays!?!? The Saturday closes were very near to Friday closes in the index level, so the distortion was over time and not DJIA trading patterns. I have no idea how the doctoral student constructed the data series, but some weeks had six trading days of closes, not five. Uh oh!

We wrote a program to cull the data and flag any historical date that was a Saturday or Sunday. It turns out that 13.9% of my beloved original DJIA 1929 series was erroneous Saturday data. As the fraction 1/7th is equal to 14.3%, the net effect was there were 1/7th too many trading days in the DJIA 1929 series compared to the current uncorrupted NASDAQ 2000 series. Over the 66-month time span of the graph, this led to a 9+ month distortion (66 months x 14%) at the end of the graph. Not knowing what else might be wrong with the Tijuana data, we dumped the series with extreme prejudice and now use a brand-new dataset from a respected commodities data firm.

The original distorted data is totally my responsibility and my fault. I should have caught it sooner. Please accept my humble personal apologies for the original distorted DJIA 1929 data and our late awareness and revision to cleaner data.

Here is the current iteration of the graph, with fresh NASDAQ 2000 and uncorrupted DJIA 1929 data not distorted with phantom extra trading days. The graph methodology of a straight-up one-to-one trading day comparison starting at the bubble tops graphed on zeroed axes is identical.

NASDAQ 2000 vs. DJIA 1929

While the two series will never have identical numbers of trading days, this iteration is much more accurate. Small differences still occur due to slightly differing market holiday patterns between 1929 and today and also unscheduled market closes unique to only one series like September 11th. This cleaned-up version of NASDAQ 1929 will be much more useful for the technical folks using it to try and anticipate a supercycle NASDAQ bottom following the Great Bear.

The 14% difference effectively stretches the NASDAQ 2000 data out wider because it is graphed next to fewer DJIA 1929 trading days. This is most apparent in a graph-to-graph comparison at the beginning of the NASDAQ series, which was changed to January 1999, and the most recent 2002 NASDAQ data. Both these points are marked above with the solid-yellow arrowheads.

With a cleaner graph, some new observations become apparent that may be useful to investors and speculators.

First, marked by the dotted-yellow curved arrows, the NASDAQ has tended to oscillate around the DJIA 1929's pioneering post-bubble bust path like a giant sine wave. Immediately after the NASDAQ crash, the NASDAQ recovered faster than the DJIA and even made two valiant attempts to continue the monstrous NASDAQ rally. Then, as soon as its second bounce attempt failed in late summer 2000, the embattled NASDAQ plunged like a meteor and traded under the path the DJIA plowed before it.

Only recently during the so-called Post-9/11 Patriot Rally, when Wall Street shamefully tugged on raw American heartstrings to seduce investors into throwing more hard-earned capital to the hungry wolves of the ongoing NASDAQ bust, the NASDAQ managed to trade above the DJIA's bust track. Above 1929, below 1929, above 1929… Any guesses as to what might come next in this series?

I remain skeptical that the NASDAQ will fall fast enough soon enough to catch up with the DJIA 1929 track again (near NASDAQ 1000 in the graph), but who knows? Maybe this great sine wave apparent oscillation between the two series has not yet run its full course. So far we have witnessed zero capitulations or selling panics to date in the NASDAQ and valuations remain stellar so anything is possible on the downside.

Ahhhh, valuations!

Wall Street continues to zealously attempt to persuade investors that NASDAQ-listed corporate earnings will soar. When? Always "next quarter!" For those of you keeping score like we are, even back in summer 2000 the tech-zealots on Wall Street paid to liberate precious capital from hard-working investors were promising an earnings recovery "next quarter." Now, eight whole dismal quarters later, talk is cheap and the markets need to see positive earnings action.

Either NASDAQ earnings must rocket or NASDAQ stock prices will plunge. Historical valuation anomalies never last very long following a bubble and always painfully revert to their mean in the subsequent Great Bear market.

The white P/E numbers in the graph above tell the whole story. The "job" of a post-bubble bust Great Bear market is to destroy speculative excess by mauling unrealistic investor expectations. In June 2000, the elite usual-suspect market darlings in the NASDAQ 100 had a market-capitalization weighted average P/E ratio of 102.6. One year ago, in June 2001, the core NASDAQ 100 valuation multiple had contracted to 74.3x earnings. Today it has tumbled even farther to 57.7x earnings.

The natural post-NASDAQ bubble bust, just as all bubble busts before it, is doing a wonderful job of dragging obscene valuations back down to earth. Paying 100 or even 50 times earnings for any big, mature company is the height of folly and the very definition of a speculative mania. The NASDAQ 1929 Great Bear mauls on and is doing its job beautifully!

In every Great Bear following a massive speculative mania bubble we have studied in history, valuations as measured by index earnings multiples always regress back below their historical mean fair value. The US equity markets have traded at an average of 13.5x earnings for over a century, so this is hard historical "fair value", corresponding to a 7.4% annual return over time. Because stocks become so extremely overvalued in bubbles, they often compensate and fall well below fair value in subsequent busts, approaching half fair value or 7 times earnings.

The probable NASDAQ bottoming territory is noted above by the dotted-yellow circle. If this bust follows historical precedent, the NASDAQ will be trading well below fair value under 13.5x earnings before the dust clears. Some tech-zealots argue that the NASDAQ should have a higher fair-value P/E since it is comprised of "growth stocks." (Their earnings sure haven't grown in over two years, have they? Then why on earth are they still called "growth stocks?") Even though it would defy all historical precedent, I could stretch to imagine a NASDAQ bottom around a P/E as high as 20x earnings if, and only if, it was accompanied by great popular investor fear and a huge capitulation panic sell-off.

The long-awaited final bottom, when the Great Bear grows tired of batting around the bleeding and near-dead NASDAQ investors, could certainly occur in the next 18-24 months as the NASDAQ 1929 graph makes apparent.

Until that final bottom occurs and the NASDAQ is universally loathed by virtually all investors, enormous danger remains in the NASDAQ Great Bear. As of the end of May, fair value for the elite NASDAQ stocks based on their earnings power was at a gut-wrenching level of 378, well under 500. Even though the long-suffering NASDAQ investors have already lost more than 2/3 of their capital from 5000 to 1500, they could easily lose 2/3 more from 1500 to 500. Great Bears do not mess around and if one is in the neighborhood it is best to take your capital and run away as fast as you can!

The moral of the story? Don't expect to get away with poking a Great Bear with sharp sticks!

There are incredibly serious reasons why the market elders' stories of Great Bears in history are so important to heed. Sure, we have instant global information today, incredible technology, and trading tools the elders couldn't even have imagined in history, but it will ultimately make little difference.

As long as human investors are subject to the immensely powerful emotions of greed and fear, there will be great booms, bubbles, bursts, and busts every few generations. While markets and technologies do change, the human heart does not, and greed and fear drive markets over the short-term.

The Great Bears of market history are equal opportunity slayers. They will merrily destroy all capital that gets in their way without prejudice. Avoid them or face ruin.

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