NASDAQ to fall 70%? (page 1 of 2)

The respected Gartner Group recently predicted that more than 90% of dot.coms would not make it. I would also add that it is likely that about 80% of all 'new economy high tech companies' will not make it.

This does not mean that all these companies will go bankrupt, but they may just languish and struggle to make money in years to come. As a result, I think that the NASDAQ 5000 level reached in mid March of this year marked the 'peak of inflated expectations,' an expression used by the Gartner Group to describe the recent speculative excesses.

This NASDAQ 5000 level may very well turn out to be as much of a 'milestone' in financial history as the Nikkei 39,000 level reached in December 1989. At the time, investors around the world firmly believed that 'this time was different' and that Japanese stocks had to be valued differently than all other stocks in the world.

When the NASDAQ reached in March the 5000 level, this Index consisted of about 4,800 stocks with a market capitalization in excess of US $6 trillion. Based on combined NASDAQ earnings estimates for the year 2000 of US$25bn, these stocks had, in March 2000, collectively a P/E of about 240!

Unprofitable issues were excluded from the P/E calculation, and I should like to stress that stocks like Cisco, Microsoft and Intel with their large market capitalization and 'relatively' modest valuations brought down the P/E of the NASDAQ.

Now, let us assumes that the NASDAQ with its $6 trillion valuation can grow its earnings at a compound rate of 20% per annum for the next ten years 'without interruption.' At the end of the period, in 2010, let us also assumes that the P/E of the NASDAQ will be twice its earnings growth rate (of 20% per annum).

In other words the NASDAQ will sell for 40 times earnings. Since the S&P 500 sells for about 28 times earnings, the assumption of a P/E of 40 for the NASDAQ is quite realistic. Under this scenario, the NASDAQ's current $25bn in earnings will grow to $155bn in ten years time and with a P/E of 40, these $155bn would have a value of $6.2 trillion.

In short, even under this extremely and, in my opinion, totally unrealistic scenario, the NASDAQ would at best be in ten years time where it was in March of this year.

Now let us assume that the NASDAQ earnings will not grow by 20% per annum but by 'only' 15% in each of the next ten years. Under this scenario, which I still regard as 'unrealistically optimistic,' NASDAQ earnings will grow to $100bn.

And again under the assumption of a P/E in ten years of twice the earnings growth rate (in this case a P/E of 30) the total market value of the NASDAQ would amount to US$3bn and an Index level of just 2,500 in 2010.

Now, I should like to emphasize the following: I am not familiar with any stock market index which, in the past, was able to grow its earnings for 10 years in a row by 15% or 20% per annum. Even to a non economist it should be clear that in the long run corporate profits cannot grow at a faster rate than nominal GDP (otherwise corporate profits would exceed GDP one day).

In fact, Professor Joseph Lakonishok of the University of Illinois has investigated whether corporate earnings can grow significantly faster than GDP. Lakonishok's research shows that in the US earnings in the 1950 - 1999 period had grown somewhat below nominal GDP.

Moreover, several studies have shown that selected group of stocks such as, today, the TMT sector are not likely to have strong and above average earnings growth for an extended period of time.