The Elusive NASDAQ Bottom

Adam Hamilton    October 12, 2001    4867 Words


Since that fateful euphoric day of March 10, 2000, the very apex of the most magnificent equity bubble in the history of the world, one of the most vexing questions on many investors’ minds has been the intrepid ever-quest to discover the elusive NASDAQ bottom.


The halcyon early months of 2000 were utterly ecstatic for NASDAQ investors.  Bullish proponents of the stellar rise of the index zealously proclaimed the proud birth a fearless “New Era”, where the enormous promise of the Internet and fantastic information-age technology had rendered the timeless rules of finance and investing obsolete.  I recall watching the rabid mania on CNBC in early 2000 and being dumbstruck that the gravity-defying NASDAQ could continue rocketing still higher further disconnecting from its underlying earnings and cashflow reality.


While the whole insane spectacle was well-known as a pure bubble in the contrarian and fundamental investor communities prior to its zenith, no one at the time knew how high the NASDAQ’s terminal ascent would carry it or when exactly the critical bubble-top summit would be reached. 


On the apprehensive day before Y2k, December 31, 1999, the NASDAQ closed at 4069.  A mere two months earlier, on October 29, 1999, the NASDAQ composite finished the day under 3000 at 2966.  In the 43 short trading days leading up to the tremendous uncertainty of the millennium changeover, the NASDAQ, which was proudly heralding itself as “The Market for the Next Hundred Years”, gained a mind-blowing 37%!  Annualized, the index was rocketing up at an unsustainable 223% rate in the last two months of 1999!  While the previous 1000 points beginning at NASDAQ 2000 had taken 329 trading days to tack on, it had taken a mere 39 trading days to leap 1000 points to the unreal NASDAQ 4000 level.


Amazingly the massive euphoric bubble continued to swell in early 2000 like a famished glutton at an all-you-can-eat steakhouse.  Timeless investment principles and rock-solid financial truths that had enabled investors to steadily build capital for many decades were thrown out the window.  The NASDAQ composite quickly burned through the next 1000 points and marched for the stars, breaching the once unimaginable level of 5000 on March 9.  It was up an incredible 111% in a single year, yet few investors found this odd.


The following day, on March 10, 2000, the index reached an all-time intraday high of almost 5133 before settling down to an all-time closing high just under 5049.  The NASDAQ bubble had finally run out of steam after a once-in-a-lifetime mania rally.


I clearly recall watching the last couple hours of trading on CNBC that day in awe and really wish I had recorded what was being said.  The gist of the comments was that NASDAQ 6000 couldn’t be far away, probably only another couple months out.  I remember one gentleman, a very prominent Wall Street personality, saying on live television that the NASDAQ composite would soon catch up with and surpass the Dow Jones Industrial Average.  This surreal day of March 10, 2000 will be forever studied by students of finance and economics until the end of human history as the quintessential example of mania bubble events and sentiment.


Ever since the mighty NASDAQ bubble burst after its final maniacal blaze of glory in early March 2000, the biggest equity game in town has been trying to divine the ultimate NASDAQ bottom.  All kinds of market watchers, ranging from highly-compensated professionals running billions of dollars of capital to young investors just beginning their lifetime investment journeys, have spent countless hours and untold dollars trying to hunt down and capture the bottom.  Although every conceivable methodology under the sun has been used to study the NASDAQ, so far no one examining the financial chicken entrails left over after the NASDAQ slaughter has been proven right in emphatically calling the ultimate bottom.


In analyzing any market, it is really important to realize that each analyst virtually always has a personal bias.  Although many analysts will claim that they are impartial, this is seldom true and analysis results are often tailored to the innate biases of the analyst.  Sometimes this happens by design and other times by subtle subconscious influence. 


Unlike most on Wall Street, I will not mislead you and attempt to assert that I am an impartial NASDAQ analyst.  I cannot claim that I am unbiased, as I have been extremely bearish on the NASDAQ since it broke through 3000 in early November 1999.  I have also been blessed with big short-side profits as the NASDAQ bubble deflated.


As an example of my consistently bearish bias on the bubble, here is a quote from an essay I wrote on August 25, 2000 called “To Crash or Not to Crash”.  For reference, on the day this essay was published the NASDAQ composite closed at 4043.


“The most likely probability for NASDAQ performance in the next 18 months, weighing in at 80% in my humble opinion, is a multi-year bear market in the index.  The brave tech investors (and we all know some) have more zeal and faith in their stocks and market than most religions can command.  They will not give up hope easily, and are likely to slowly go down with their mortally wounded ship, the USS NASDAQ.  The only likely way the backbone of irrational investor hope in companies valued at 100x to 3000x earnings will be broken is through a gut-wrenching and excruciating multi-year bear market.”


My unashamed bearish bias laid naked, however, I love technology and can’t wait to invest in the super tech-stocks once again when we reach the ultimate bear market bottom.  The whole goal of investing is to buy low and sell high, to deploy capital in fundamentally undervalued investments at low prices and then sell those same investments at high prices when they become fundamentally overvalued.  I have nothing against the NASDAQ and I am a raging optimist for the young Information Age, but I simply want to pay a fair-to-low price for tech companies based on the cashflows they can spin off for me as an investor.


Contrary to popular mythology today, there is nothing patriotic or wise about throwing money at overvalued investments.  Actually, that course of action is pure foolishness which ultimately leads to nothing but poverty and ruin.  At Zeal Research we study markets, geopolitics, economics, finance, history, and fundamentals and attempt to profitably use all this information to help our clients first preserve and then enhance their scarce and valuable capital.  The trendy quest for the elusive NASDAQ bottom is incredibly important as vast amounts of capital ride on this key mystery.


We constantly monitor the NASDAQ because we want to know when the timing is right to jump back in on the long side and also because there are huge profits to be made in riding the index down to the bottom on the short side.  Even though the NASDAQ is far less important than the Dow Jones Industrial Average or S&P 500 in absolute terms, it has become the de facto popular proxy for US stock market performance precisely because it gained so many new fans as it roared to its terminal bubble apex.


The goal of this essay is to once again throw our opinions into the fray on the elusive NASDAQ bottom.  For many reasons we believe that the post-attack NASDAQ closing low of 1423 on September 21 is NOT the ultimate bear market bottom for the NASDAQ.  Since this essay would evolve into a small book if we articulated all the reasons why we think we have not yet witnessed the ultimate NASDAQ bottom, we are limiting the scope to three primary discussions.


First, we offer some thoughts on the volatility signatures that are ubiquitous after bubble tops and ultimate bottoms, then we will move into mean returns and typical bear market behavior following bubbles bursting, and finally we will close with the hyper-critical valuation fundamentals of the NASDAQ.


Last November we published a popular essay titled “Volatility Squared”.  It documented some historical research we had done on classic bubbles, bursts, and busts.  The thesis of this essay was that long-term bear market bottoms following bubbles are marked with a distinct intraday volatility signature.  Intraday volatility is the absolute percentage range in which a stock index moves each day in terms of its previous daily close.  It is calculated for any given day by subtracting the intraday low from the intraday high and dividing the difference by the previous day’s close.


After an initial bubble-bursting crash event, the 100-day moving average of intraday volatility spikes dramatically to form the first volatility top.  Later, as the bear market bottom is reached, the wholesale capitulation panic that marks this event is also highly volatile.  It forms a second volatility top which together with the first one creates a distinct and easily-identifiable double volatility top.  For more information on this “double volatility top” concept as well as graphs of famous examples in history, please visit our website at and skim “Volatility Squared” from November 2000 and “Equity Bulls in Denial” from May 2001.


Incidentally, I closed the “Volatility Squared” essay with the following paragraph on November 17, 2000 when the NASDAQ closed at 3027.


“Where is the ultimate NASDAQ bottom?  It is impossible to predict with any certainty, but the 100-day moving average of intraday volatility indicates that it is not yet in sight and is MUCH lower than 3000.  The NASDAQ perma-bulls have been wailing and gnashing their teeth because they have had a tough year. We believe they ain’t seen nothin’ yet!”


As we continue to monitor the NASDAQ based on the concepts articulated in those earlier essays, we do not believe that the NASDAQ has yet exhibited the proper double volatility top signature that marks past bear market bottoms.  Here is a current graph of the data, with the red line representing the 100-day moving average of NASDAQ intraday volatility.



The first volatility top is very distinctive, highlighted with the dashed yellow circle above.  It occurred as the NASDAQ crashed in March and April of 2000.


Yes, the NASDAQ crashed!  Although Wall Street still denies that this crucial event was a classical crash because they don’t want to contemplate the high probability of a brutal post-supercycle-bubble bear market, the NASDAQ crash is undisputable.


How do we know?  For over a year we have been running a graph on that superimposes the Dow Jones Industrial Average of 1929 over the NASDAQ of 2000.  When the NASDAQ is dilated to a 2:1 time scale to simulate faster information flow today compared to 1929, the indices are virtually interchangeable.  This now notorious Internet graph of the current NASDAQ and the DJIA of 1929 was first discussed in our “To Crash or Not to Crash” essay we quoted from above.


In a priceless reward for our humble attempts to help people understand markets from a long-term fundamental perspective, countless investors have written me and said they have saved large amounts of capital because they saw this single graph.  I can’t even begin to express what a joy and blessing it is to hear that some investors have been spared the ravages of the vicious NASDAQ bear market because they saw this bubble-to-bubble comparison and realized that the bearish case for the NASDAQ was extraordinarily strong even back in the summer of 2000.


Back to the graph above, the blue “1” marks the initial crash in the NASDAQ that ramped up volatility high enough to create the first volatility top marked with the red “1”.  The apparent second volatility top, marked with the red “AB” above, is where the current NASDAQ situation really gets interesting.


The first hump in this apparent second volatility top, marked with the red “A”, was spawned in the gut-wrenching NASDAQ sell-off marked with the blue “A”.  The second hump, marked with the red “B”, corresponds to the blue “B” sell-off that commenced after the temporary euphoria of the Greenspan Gambit of ultra-aggressive Fed interest rate cuts wore off for the markets.  Although with a quick glance “AB” looks like a real second volatility top, we think it is a FALSE volatility top for several reasons.


First, because we use a lagging 100-day moving average to smooth raw intraday volatility, the actual volatility top lags the volatile selling event that caused it.  In our studies of historical double volatility tops, the ultimate second volatility top occurs AFTER the ultimate bear market bottom.  With the NASDAQ plunging towards its April lows even before the terrorist attacks, it is readily apparent that the “V” shaped rally off the April lows did not mark the ultimate NASDAQ bottom, as we have articulated in numerous essays including “Equity Bulls in Denial” published on May 11, 2001 when the NASDAQ closed at 2107.


In our historical studies the second volatility top has ALWAYS occurred AFTER the ultimate bear market bottom, not before.  As the April low was shattered after the attacks, there is no way that intraday volatility top “AB” above could be the honest-to-goodness real second volatility top marking the ultimate bear market bottom for the NASDAQ.


One of our cornerstone tenets at Zeal Research is that history is THE best professor for teaching how markets work.  Not surprisingly, there is a monumental historical example of a false second volatility top preceding the ultimate real bear market bottom and REAL second volatility top.  Following the infamous DJIA 1929 crash, a false second volatility top appeared marking a precipitous slide that was not yet near the ultimate bottom.  We highly encourage you to visit and look at the second graph of our “Equity Bulls in Denial” essay that clearly shows this false second volatility top of the 1929 DJIA debacle (marked with a “3” in the graph).


False apparent second volatility tops appearing early are to be expected and the current NASDAQ has thrown the same kind of intraday volatility head-fake at investors.  The more things change in markets, the more they stay the same.  Without the proper long-term strategic historical perspective on current market and economic events, investors today are doomed to repeat the dangerous mistakes of history rather than wisely heeding the tough lessons painfully learned by our ancestors about booms, bubbles, bursts, and busts.


The real ultimate NASDAQ bottom will be marked by the real second volatility top which will occur AFTER the bottoming event.  We have not yet witnessed the elusive NASDAQ bottom!


Finally on the graph above, please note the dashed yellow arrow.  The September 21, 2001 post-attack NASDAQ closing low of 1423 is still slightly above the October 8, 1998 closing low of 1419 following the Russian Debt Crisis/Long Term Capital Management derivatives disaster.  We still strongly believe that the ultimate bear market low in the NASDAQ will wipe out far more than a mere 18 months of gains.  Here is a quote on this front from “Equity Bulls in Denial”.


“…major secular bear markets after bubble bursts typically wipe out 10-15 years of equity gains.  As the yellow line in this graph shows, the April 4 NASDAQ low was far above even the October 1998 low.  The odds of this brutal NASDAQ bear market only wiping out a mere 18 months of gains (from October 1998 to March 2000) and then going back into hibernation are so trivial as to be laughable.  A true bear market is not so merciful as to only maul 18 months of gains. For a startling comparison, the NASDAQ low in 1990 was 325. If history proves to be a valid guide yet again, that level is much closer to where the true NASDAQ bottom will be than the lofty 1650 range in which the perma-bulls and the bullish-bears have foolishly placed their faith.”


One only has to shudder at the recent seventeen year lows on the post-bubble Japanese Nikkei 225 to see a wicked example of how a genuine post-bubble bear market operates and indiscriminately mauls many-year-old stock market gains.  NASDAQ investors today would do well to study the horrifying Japanese bubble which burst in 1989.


Our next graph zooms out for a wide-angle strategic perspective of the NASDAQ since 1990.  The embattled index is graphed under a yellow 7.5% standard return line beginning on the first trading day of 1990.  7.5% is the historical average of equity market returns over centuries.  Sometimes markets return more than 7.5% but these boom episodes of history are inevitably followed by busts where markets either lose ground or earn far less than 7.5%.


The 7.5% number is derived from taking the inverse of the historical average stock-market price earnings ratio of 13.5, which is roughly 7.5%.  For a deeper discussion on why this is so and some of its implications for equity investors, please surf to and skim our “US Equities: A Strategic Perspective” essay published on July 13, 2001 when the NASDAQ closed at 2085. 



If investors don’t know where we have been, they have little hope of figuring out where we are going.  This decade-plus long-term strategic perspective of the NASDAQ will be zealously studied in the future as the perfect example of an equity mania boom leading to a bubble, the crash in the burst phase, and the ugly bust eviscerating investors’ capital as the bubble was excruciatingly unwound.  Just as a military commander lacking the vital strategic perspective can easily be massacred in battle, investors stuck in the short-term tactical mire can be easily slaughtered by the crushing valuation tides of the markets.


The dashed red line above corresponds to the post-attack temporary NASDAQ low and the 1998 NASDAQ low following the Russian Debt Crisis.  From a longer-term perspective than the first graph it is quite obvious just how far above the yellow normal 7.5% return line that the mighty NASDAQ bubble of the 1990s really towered.


Provocatively, on the very day of the latest post-attack September 21 NASDAQ low of 1423, the historical mean return line was at 1115.  The most recent post-attack low was incredibly 28% HIGHER than the NASDAQ would have been if it had followed a normal trajectory in the 1990s.


In all the booms and busts my colleagues and I have studied, in all kinds of markets from stocks to commodities, from bonds to derivatives, in many different countries and many different epochs of history, we have never discovered a single mania boom that was not followed by a bust which carried the market well below historical mean return levels.  Mean reversion is one of the most rock-solid principles of market operation ever observed.


As many sagacious contrarian commentators have pointed out in the past, the magnitude of a bust is often symmetrical and congruent with the magnitude of the preceding boom.  The more extreme the mania, the deeper the dark market days in the bust.  Since the NASDAQ bubble was the biggest speculative mania in the history of humanity, we are convinced that the ultimate bottom is far, far below current lofty levels and that history will not be mocked.


If history is proven correct once again, the ultimate NASDAQ bottom is probably somewhere around 500, definitely not 1400.  Busts following booms carry markets far below normal valuation ranges, and we do not believe the NASDAQ will be the first exception in history, even with extensive Federal Reserve and US government blatant market manipulation notwithstanding.  We are nowhere close to the ultimate NASDAQ bottom dear friends!


Finally, the most solid and irrefutable measure of market price levels is valuation. 


Valuation is a critical investing concept that enables investors to discern what kind of cashflows an investment is likely to spin off for its owners.  These cashflows (or earnings as a long-term proxy for cashflows) are then compared to current market prices to determine valuation.  The most popular measure of valuation is the humble price-earnings ratio, which is always maligned during booms but ultimately never fails to prove a true and valid measure of valuation over long-term time horizons. 


We have hammered home the supreme criticality of valuation in literally dozens of past Zeal Research essays and truly believe it is one of the single most important cornerstones of successful strategic investing.  After all, if an investor doesn’t know what an investment is worth, how will he or she be able to buy low and sell high?  As recent market events are beginning to abundantly prove once again, investors who ignore valuation fundamentals do so at their own peril and are carelessly jettisoning their capital into an abyssal black hole never to be seen again.


Our final graph shows the valuations of the NASDAQ 100 each quarter since after the crash.  The P/Es shown below are from the NASDAQ 100, the 100 biggest and best NASDAQ companies, while the broader NASDAQ composite (which contains the NASDAQ 100 companies) is graphed as the blue line.  The NASDAQ 100 companies are a valid proxy for the NASDAQ as a whole, which once sported well over 4000 listed stocks in early 2000 but now is languishing around 3700 listed companies.


Also, the P/Es shown below are very conservative.  They are market-capitalization weighted average (MCWA) P/E ratios calculated based on the P/Es of individual NASDAQ 100 market-darling companies.  Once a NASDAQ 100 company begins losing money, which many have, its losses are not used to offset other companies’ earnings but are simply ignored.  If one was to take aggregate NASDAQ 100 income without excluding the losers as we have here, the P/Es shown below would be far higher.  We believe these NASDAQ 100 MCWA P/Es are very conservative and useful measures of the fundamental valuation of the ever-decreasing segment of the elite NASDAQ 100 that are still scraping out some profits.


The ancestor of the following graph was originally run in our essay called “The Greenspan Gambit” published on January 5, 2001 right after Alan Greenspan’s first emergency 50 basis point rate cut and the epic beginning of his latest frantic easing cycle, the most aggressive in the entire 88 year history of the Federal Reserve.  The NASDAQ closed at 2408 the day this essay was published.  Here is a quote.


“If low interest rates, rapidly mushrooming cheap credit, and wild-west capital arrangements could stave off a post-bubble bust, the Nikkei would be trading over 100,000 today.  The Japanese reliquefication strategy failed even though the Japanese people had an enormous trade surplus, the highest personal savings rate on the planet, and relatively high consumer wealth.  If lower rates and cheap credit couldn’t help the hard-working Japanese economy, the Greenspan Gambit may as well be stillborn in the States.”


Just for the irreverent heck of it, we decided to throw in a bull graphic if Wall Street was bullish at the time of each NASDAQ 100 P/E reading or a bear graphic if Wall Street was bearish on the NASDAQ at the time.



Come on now.  Is anyone honestly surprised there are no bears in this graph? 


The primary mission of Wall Street is NOT to make investors money, but to make Wall Street firms money.  Sometimes these two goals mesh fairly well, as in big bull markets.  But when Wall Street is forced to decide between making money for itself by persuading people to buy, buy, buy no matter what during bear markets or protecting the scarce capital of investors which lowers Wall Street profits, Wall Street always chooses to throw investors to the wolves so it can profit itself.  This is nothing knew and has happened many times in the past. 


As the ancient King Solomon, one of the wisest men who ever lived, sagely pointed out in his book of Ecclesiastes, “There is nothing new under the sun.”  Wall Street exists to make Wall Street money.  The financial establishment will be hyper-bullish all the way down the NASDAQ bust to the ultimate bottom, at which point many on Wall Street will wail in despair and some will claim that the Age of the Common Stock has forever eclipsed.  You will NOT see a NASDAQ bottom while Wall Street and the financial establishment is overwhelmingly bullish.  Bottoms occur on wholesale capitulation selling panics, not ubiquitous and pervasive bullish propaganda.


Tracking the NASDAQ 100 MCWA P/E through the deflating NASDAQ bubble and unfolding bust has been fascinating.  It was at stellar heights after the first post-crash bounce, but then began slowing falling as NASDAQ prices continued their painful slow downward spiral to reality.  In Q2 2001, the P/E shot back up as the “E” in P/E ratios, earnings, imploded with the slowing US economy. 


At the end of Q3 2001, our conservative measurement of the NASDAQ 100 P/E excluding the growing ranks of companies losing money was still vastly overvalued at 32.2.  By comparison, stock markets during the bottoms of historical busts have traded below 13.5 times earnings without exception.  On a macro-scale, periods of undervaluation, P/Es under 13.5, always follow periods of overvaluation, P/Es over 13.5.  Markets always ultimately regress to their mean valuation.


We don’t believe the elusive NASDAQ bottom will draw near until the 100 biggest and best companies on the NASDAQ are trading at a market-capitalization weighted average P/E ratio between 7 and 10.  Once again, doing some quick-and-dirty math on my fingers, that puts the ultimate NASDAQ bottom around 500 based on current earnings, not 1500.  If NASDAQ earnings continue their abyssal plunge, the ultimate bottom could even be lower than that!  Post-bubble bear markets are NOT casual events and they slaughter immense amounts of investor capital.


Finally, please note the dotted red top resistance line of the NASDAQ in the graph above.  It is drawn from the March 2000 bubble top through the top of the first bounce following the NASDAQ crash.  It is quite apparent that the besieged NASDAQ still has yet to break decisively above this key resistance line.  It is yet another small bit of information that illustrates that the NASDAQ is looking quite ugly from a technical perspective as well as from the other fronts we have discussed in this essay.


The elusive ultimate NASDAQ bear market bottom is yet nowhere to be seen and the September 21 low of 1423 was NOT “The Bottom”!


I truly feel sorry for the investors who lost money in the NASDAQ after the crash.  I started my first business when I was eleven years old (extracting golf balls from water traps to sell to golfers) and I began investing my business profits when I was twelve.  In a lifetime of investing, I have seen feast and famine, made lots of money and lost lots of money.  I truly do understand how difficult it is to watch losses accrue in a market and how the natural psychological defense mechanism is to bury one’s head in the sand and try to ignore reality.  It is no fun watching an investment you own slide into oblivion and it is really easy to lose sight of the fundamentals.


Yet, investing IS inherently risky.  It is ultimately refined gambling.  There is no such thing as a sure thing.  All investors, regardless of where they are deploying their capital, have a duty to themselves to do their own due diligence.  Relying on Wall Street, or anyone else, is no excuse for investment losses in the Information Age.  There are endless good investment resources floating around the Web and around conventional libraries and investors have to accept responsibility for their own capital and their own financial destinies. 


NASDAQ investors are no exception and they owe it to themselves and their futures to start investigating historical booms, bubbles, bursts, and busts before it is too late to salvage any of their capital.  While a 70% loss hurts, it pales in comparison to a 90% loss which is very probable at the ultimate NASDAQ market bottom.  The DJIA in 1929 ultimately fell 89% from peak to trough over a few ugly years.


To dig out of a 70% loss, a NASDAQ investor has to make a 233% gain, which is quite challenging.  Yet, if the same investor is paralyzed into inaction by perpetually bullish rhetoric and propaganda spewing from Wall Street, the potential for a 90%+ loss is very real.  One has to make a stupendous 900% gain to dig out from under a 90% loss, which is exceedingly difficult.  There is an ENORMOUS difference between getting out now and sitting out the vicious bear or waiting hopefully as the NASDAQ craters and then selling in utter despair at the ultimate capitulation selling panic marking the real bear-market bottom.


Any way we look at the current NASDAQ, my colleagues and I strongly believe it remains grossly overvalued and nowhere close to its ultimate elusive bottom.  We zealously encourage all NASDAQ investors on the long side to do their own homework on bubbles and busts throughout history.  Capital enhancement is not possible unless the scarce capital is first preserved, and being long in a bear market like the NASDAQ during a supercycle bubble bust is NOT the way to preserve precious capital.


If this current NASDAQ catastrophe continues to follow historical precedent, which it has tracked perfectly so far, the elusive NASDAQ bottom remains far below current index levels.  Caveat Emptor.


Adam Hamilton, CPA     October 12, 2001     Subscribe