Ashby

Dr. David Ashby is a Certified Financial Planner and the retired Peoples Bank Professor of Finance at Southern Arkansas University.

On Monday, January 24, the Dow Jones industrial average plummeted more than 1,100 points during the day. That sounds like a big move, and it is, but given the current Dow level, it was roughly a 3 percent decline. Maybe 3 percent sounds better to you than 1,100 points. Maybe not. Either way, if you were tuned in to CNBC or Fox Business, you might have had a nervous pit in your stomach. Remarkably, however, the Dow ended up 99 points by the end of the day.

Those whipsaw moves weren’t confined to the Dow. The Nasdaq index fell by almost 5 percent during the same day, but also ended up positive! It was an unusually volatile day in the market, fueled largely by speculation that the Fed might raise interest rates for the first time in forever by as much as a quarter point. Oddly enough, concern over that interest rate hike seemed to have precedence over the potential invasion of Ukraine, a matter that seems to be more potentially disruptive to world economies.

I don’t encourage focusing on a single day of trading. Except for the fact that I just reminded you of it, you’ve probably forgotten about January 24 by now. But how about a look at where markets are now versus over the last 12 months? During 2021, the Dow reached several new highs, with the all-time high closing at 36,952. As I write this, it is at 34,297, off its all-time high by a little over 7 percent. Let’s look at the Nasdaq. Over the last year, it reached a high of 16,212. Currently, it is at 13,539, a decline of 16.5 percent.

Why such a steep decline in the Nasdaq versus the Dow? The answer is somewhat related to the pandemic and technology. The Nasdaq contains many technology stocks that benefitted from the shift to the work at home/shop at home environment. The Dow contains more traditional (perhaps downright boring) industries such as manufacturing and food processing. And the financial media certainly hyped the technology companies, pushing values to the extreme. Only a few years back, Apple became the first company with a stock market value exceeding $1 trillion. At one point in 2021, we had half a dozen companies with a market valuation of a trillion or more and Apple with a valuation exceeding $3 trillion.

Speaking of valuation, let’s take a little deeper look at the Nasdaq versus the Dow. A common way of stock market valuation is the price to earnings ratio, or PE. For example, a PE of 15 means the price of the stock is 15 times higher than its earnings. As a baseline, a common long-term average for companies is a PE of around 20. At mid-year 2021, the Dow was trading at a PE of around 24. But the Nasdaq was trading at a PE of 37, almost double the long-term norm. Enthusiastic investors had bid up the value of those tech stocks far above long-term normal valuations. When a market correction occurs, those highflyers have more room to fall than more conservatively valued stocks.

If you’ve been a long-term market investor, you may recall the technology bubble of the period 2000 to 2002. Frenzied buying had bid technology stocks to exorbitant levels. During that period, the Nasdaq declined by more than 75 percent. Over that same period, the Dow dropped by 24 percent. As Mark Twain once said, “history may not repeat itself, but it sure does rhyme!”

Your takeaway: it’s probably best to avoid chasing high flying stocks and investments that have recently exhibited outstanding returns. They may be overvalued, and you may be getting to the party late.

Dr. David Ashby is a Certified Financial Planner and the retired Peoples Bank Professor of Finance at Southern Arkansas University. He holds degrees in accounting and business administration and a doctorate in finance from Louisiana Tech.

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