There was a lot of excitement around the Nasdaq breaching the 5000 mark yesterday for the first time since March of 2000. Not that I’m not nostalgic, but aside from it being a nice round number it is fairly meaningless. Some will mention that inflation adjusted yesterday’s achievement is a non-event, and that the profitability of the companies that compose the index dwarf that of the dot.com era, or that valuations for stocks are nowhere near the stratospheric levels they were at 15 years ago. But not for nothing, the milestone gives us the opportunity to consider where and why we are back at these levels. At the lows in October of 2002, just above 1100 I thought as many did that it would take multiple decades to make new highs, certainly not 15 years.
What I find most interesting is plethora of former tech peeps, pundits, strategists and investors/traders who are trying to explain why its different this time. And of course, it is different this time, but one thing that remains the same. The Finance-Industrial Complex has a vested interest in the investing public remaining comfortable with the notion that risk assets will continue to go UP. You are familiar with the declarations, the tech correction in 2000 was a “healthy re-set of over exuberance”, or the “sub-prime mortgage situation was contained” in 2007, or the decline in industrial commodities is temporary, but a in the meantime it’s a “nice tax cut” for you to go out and buy crap you don’t need.
But for me, someone who lived and traded through the inflation of and subsequent destruction of the dot.com bubble in the late 1990s and early aughts, there is one massive difference between the bull market of the 1990s and that of the last six years. Interest rates. The chart below of the yield of the 10 year treasury bond over the last 20 years is fascinating:
The last time the Nasdaq Composite was at 5000 the yield on the 10 year Treasury Bond was above 6%, down from 12% in 1985 fifteen years earlier. Now, 30 years on, we are at 2%.
There has been few alternatives and little reason to invest in anything else other than stocks. Thinking about it another way, in a consumer led economy like ours, the government has been able to borrow for years at ridiculously low rates while forcing the public to invest their invest-able capital in the companies that are the engine of our economy.
This has worked out pretty well except for the fact that the shell game might be very close to being out of moves. If rates stay this low for too long there is certainly going to be a risk asset bubble of epic proportions considering today’s starting point, and we know how it will end. Interest rates really can’t go much lower (obvious exceptions in Europe), but risk asset valuations could be soon considered very expensive if they are not coupled with real earnings and sales growth as opposed to the result of financial engineering.
So what’s different this time? It’s simple, for the last 6 years ZIRP is what has gotten us here. Not some mania around new found innovation that was about to change the world, or the belief that every man woman and child in America deserved to own their own home, and a vacation home and condo to flip, regardless of credit worthiness. This time around risk asset valuations are where they are as a simple result of crisis policy that turned into monetary policy and now we just need to hope that the powers that be in the Finance-Industrial Complex have a clue how to nail the landing.
I have no clue which direction the next 50o points in the Nasdaq go. I suspect the path of least resistance remains up, but as I have mentioned before in this space (MorningWord 2/6/15: The Path of Least Resistance Remains… UP), the Fed is likely damned if they do but much more dammed if they don’t. For those of you who cringe at these sorts of opinions and don’t believe in market timing, that’s all fine and good. But just like 2000-2002, and 2007/2008 we are likely very near (next year or two) equities getting hit hard. The real question is from where does that correction start? And for us, how will we react when a small correction turns into something more?