Equity investors celebrating the Dow Jones Industrial Average and knocking on the door of 29,000 should remember what exactly happened 20 years ago.
On January 14, 2000, the Dow
DJIA, + 0.29%
reached its peak before the internet bubble burst. And yet you would never have known if you had read what the editors of the newsletter said at the time.
After reading my newsletter archives from January 2000, I actually noticed the similarities between now and then. For example, a newsletter editor said in mid-January 2000 that he was encouraged that the Fed would signal that it would not raise interest rates as aggressively as previously thought. Another said, "Inflation is dead." A third celebrated the strength of the economy, which was reflected in robust consumer spending during the recent Christmas season.
Sounds familiar? However, these similarities do not mean that the US market is at or near a top. But they illustrate the false consolation we gain when we say to ourselves that a bear market cannot happen because the economy is strong, moribund inflation and accommodating the Fed.
As we know, the Dow-Top ushered in a long period of disappointing performance in January 2000. At the end of 2011, the Dow was no higher than in January 2000. If the future repeats this segment of market history, the Dow would not be higher at the end of 2031 than today. This sobering thought undoubtedly offers evidence of reality for any exuberance.
There are three important ways to mark the 20th anniversary of the top in January 2000:
1. Reviews are important
Valuations are important for the long-term prospects of the market. The stock market was undeniably overvalued in January 2000. To show this, I calculated the “Z-Score” for each of the eight standard evaluation indicators on January 14, 2020. (This score indicates the number of standard deviations from which the indicator comes the historical average.) The average Z score of these eight indicators was extraordinarily high at 2.2.
This is noteworthy in that statisticians often use a z-value of 2.0 or higher to indicate that the deviation of a particular measurement from the average is almost certainly due to more than normal fluctuations. The good news is that the market today is not as overvalued as it was back then. As you can see in the graphic opposite, the average Z-Score of these eight indicators is 1.5 today. This is a significant improvement over version 2.2, which prevailed 20 years ago.
However, it is not clear how much the bulls should celebrate. Two indicators – the price-performance ratio and the Buffett indicator – have higher z-scores than in January 2000. In the late 1990s, most indicators are higher today than at almost any other time in US history.
Read: Americans currently own a lot of stocks – and that's a bad sign
2. The assessment is not a good short-term indicator
Another reason not to get too much comfort from the currently prevailing lower z-scores is that the ratings say little about the short-term direction of the market. You may recall that the market was overvalued in the mid-1990s, but stock prices continued to rise for a few more years before they finally succumbed to gravity.
The Dow's total return over the 20 years since its peak in January 2000 is only 6.9% on an annual basis.
Even if the stock market continued to rise in the coming years and was overvalued even more, as in the late 1990s, its long-term outlook would be mediocre at best. Even taking into account the extraordinary performance of the stock market over the past 10 years, the total return of the Dow in the 20 years since its peak in January 2000 is only 6.9% on an annual basis – hardly half of the long-term average.
3. Pay attention to deviations
The third notable reason for this 20 year existence is that differences indicate an unhealthy market. You may recall that unlike the Dow bull market high in January 2000, both the Nasdaq Composite
COMP, + 1.04%
and the S & P 500
SPX, + 0.70%
didn't make it until March, two months later.
According to Hayes Martin, President of Market Extremes, an investment advisory firm focused on key market turning times, this split was due to the low technology exposure in the Dow. There was an associated split between growth and value: the 30 Dow companies were closer to the end of the growth value spectrum than the companies in the Nasdaq Composite or the S & P 500.
It was not a healthy separation. Fortunately, Hayes said in an email today, “there is no such split market. All sectors are focused on growth, value, technology, healthcare and finance and have reached new highs in the past few days. "
The final result? The market is in better shape than 20 years ago, but not enough to get irrationally exuberant.
Mark Hulbert regularly writes articles for MarketWatch. In his Hulbert Ratings, investment newsletters are tracked for which a flat fee is charged. He can be reached at firstname.lastname@example.org
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