Dow Milestone

The Lehmann Letter (SM)

The stock market was down in mid-session-trading today, but the Dow recently passed an important milestone. It's now higher than the peak reached 11 years ago.

The Dow closed above 11,700 in 2000 at the height of the dot-com boom, and went on to close over 14,000 in 2007 with the peak of the real-estate bubble. The Dow has been trading in a range for over a decade, and must rise another 25% to break out of that range.

The NASDAQ's story is different. It's at 2,700, about half of where it was at the dot-com peak, and has not done as well as the blue-chip Dow. The NASDAQ is heavily weighted by technology and small-capitalization firms that suffered severely in the dot-com collapse. More than a decade has gone by, yet they still show the damage.

The S&P 500, which most observers believe to be the stock market's best representative, is still about 25% below both its 2000 and 2007 peaks. Think of the S&P as lying between the blue-chip Dow and the small-cap NASDAQ. Its 500 stocks represent the market's spectrum from small to large firms.

What does this mean? It demonstrates the damage done by the dot-com boom of over a decade ago. Stock market valuations raced ahead of earnings (the P/E soared) and then crashed back to earth. Investors curbed their enthusiasm in the ensuing decade, returning P/E valuations and the stock market to more modest levels. Then the Great Recession crushed the stock market once again.

Investors have been - and remain - cautious, and rightfully so. Fool me once, shame on you. Fool me twice, shame on me. That's why it will take a while for the stock market to break out of its range.

© 2011 Michael B. Lehmann