Why “The Market” Is Not What You Think It Is

With the current market environment looking more and more like that of the late 1990s, I decided to revisit that time in chart form and see what potential pitfalls exist for investors that can be avoided this time around.  I think you will agree that the pictures below are both informative and frightening, the latter being the case if you do not account for the vast difference in performance between the two stock exchanges that make up the U.S. Stock market.

U.S. Stocks are either listed on the Nasdaq or the New York Stock Exchange (NYSE).  I have covered recent performance of these two groups in other articles, and the bottom line is that the Nasdaq has trounced the NYSE for about 3 years now.  That’s great if your objective is growth from a tech/biotech-driven portfolio.  But if investment income to fund your lifestyle is a key part of what you are investing for, your returns have been OK, but you could be forgiven for having a bit of Nasdaq-envy.  The issue now as it was back in the late 1990s is that investors do not realize that these two very distinct groups of investment options (Nasdaq and NYSE) have very different compositions.

In particular, there is so little quality dividend income available on the Nasdaq, equity-income investors cannot really allocate much at all to that group.  As an income-driven investor, I am OK with that, but it does take some explaining at times like this, when the Nasdaq is producing the vast majority of the returns of the S&P 500.  You see, the S&P is what most investors and the media report all day, every day and it has become “the market.”  I challenge you to go beyond those headlines and in addition to tracking the market via the S&P 500, be aware of the ongoing relative performance of the Nasdaq and the NYSE Composite Index.  This will help you avoid being “faked” into making portfolio decisions that actually go against your investment objectives.

One last point before we hit the charts.  The Nasdaq Composite contains hundreds of stocks, but the focus for many investors is the Nasdaq 100, a subset which contains the largest stocks listed on that exchange.  In a world of ETF obsession, the Nasdaq 100 ETF (symbol QQQ) has become very popular, and this has created somewhat of a self-fulfilling prophesy regarding those stocks.  They are driven up in price because assets are flowing in, and assets are flowing in because the price keeps going up.  Keep that in mind as you review the charts below.

CHART 1: 1999-2002

Market 1999 - 2002

Here is the Nasdaq 100 and the NYSE from the start of 1999 through the end of 2002.  It looks a lot like the tortoise and the hare.  The latter creature (Nasdaq 100) doubled in just over a year, lost it all before the following 12 months had passed, and continued down more than 50% from where it started in 1999!  The NYSE produced decent returns during the first 18 months of the period, then joined the Nasdaq 100’s slide, though at a much lighter pace.  When the four-year period was done, the NYSE portion of the “market” had lost a big chunk of money as well (22%) but looked pretty solvent versus the Nasdaq 100’s fall from grace.

This is why I favor a long-short approach to investing.  Bear markets will happen, but for income investors, it makes sense to take direct steps to reduce the risk of major market declines, while continuing to let the dividend income flow.  “Going to cash” with your portfolio assets may help you try to sidestep some of the bear, but it will also turn off the spigot on the cash flow you need to live your life.  Long-short investing with a dividend focus can potentially solve that issue.

CHART 2: 1999

Market 1999

Since its human nature to break down market movement by calendar year, let’s do just that, starting with the manic year of 1999.  The Nasdaq 100 gained nearly 80%, the media tried to convince us that bear markets and the business cycle were kaput, and portfolio managers who did not jump head-first into the technology stock vibe were ridiculed, or simply saw their asset bases shrink.  Does that sound like today’s world?  It sure looks to be heading that way, what with the surge in interest in passive investing, and investors’ willingness to buy technology stocks at any price.

CHART 3: 2000

Market 2000

For the first time in 1000 years, the first digit in the calendar year changed. And for the first time in at least 10 years, the stock market started what would be a major decline.  But that did not occur until the Nasdaq 100 portion of the market ripped higher one more time, during the first 3 months of 2000.  By March, the Nasdaq 100 was up about 25% year-to-date, while the NYSE Composite had gained “only” 3% (about 1% per month).  As you can see, the rest of the year was fast and furious decline for Nasdaq 100, a big trading range through the summer, and then an autumn to forget. Meanwhile, the NYSE traded in a narrow range the rest of the year, and dividend investors kept collecting their income.

CHART 4: 2001

Market 2001

More of the same for the Nasdaq, which had suddenly become a dirty word.  The NYSE held in, but still dropped for the year, though many of its components were up for the year.  Naturally, the disaster of 9/11 took an already rough situation and made it worse, with the stock market closed for several days and the world in shock mode.  But from an investment standpoint, the damage to investors was already well down its path.

CHART 5: 2002

Market 2002

In the final year of this 4-year stretch, the market (both Nasdaq and NYSE segments) go from bad to worse, before the ultimate bottom is reached in March of 2003.

As at the end of the last century, the current Nasdaq-dominated market is likely to continue until something pops the bubble.  While this is happening, it severely distorts the use of the S&P 500 as a market indicator.  Too many investors are unaware of this.

Eventually, it all unwinds, and probably faster than many investors expect it to.  Don’t be part of the large group of investors that will be surprised when this happens.  Align your portfolio with your objectives and keep prodding away at pursuing those objectives.  And resist the temptation to oversimplify what the “stock market” is and how it is doing.  It will go a long way toward preserving and growing your wealth in the coming years.

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Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors.