I've got some time on my hands, so I thought I'd throw off some thoughts on the recent market travails, particularly the technology part of the market. I'm not a particularly big technology investor -- outside of Echelon (Nasdaq: ELON) -- but I never let ignorance and inexperience hold me back from having a strong opinion. I realize that there's no paucity of opinions analyzing the ins and outs of market movement, particularly as the gyrations get more choppy as they have recently. Hey, at least I'm not talking about the election.

8 million stupid lessons
It's now required by law that every self-help article includes some cliché about turning every mistake, failure, and experience into a lesson. That's OK advice, until you find yourself in a place like the stock market. Actually, it's OK advice anywhere, so long as you make sure to learn the right lessons, which often means learning no lesson at all. Go to any casino in Las Vegas and you'll see students standing around large, spinning fruit bowls carefully noting the location of a little piece of metal when the bowl stops spinning. Of the trillions of patterns and correlations that emerge, almost none will provide any real information. But, as long as the patterns are discernible, people will be there to mark 'em down and call them lessons learned. Next time four reds follow three greens, halve your wager.

When the Nasdaq was climbing toward, I guess, infinity, lessons learned on the boards (and sometimes from more formal sources) came from the people who had jumped out of Internet Capitol Group (Nasdaq:  ICGE) or CMGI (Nasdaq: CMGI) 800% too early. The consolation came, supposedly, from the market's expensive lesson that buy-and-hold-great-companies-no-matter-what is the way to go, leaving a wiser, if poorer, investor in its wake. Investors whose class started after the market had really gotten heady saw stocks wave good-bye to 80%-90% of their market values and thus pronounced that they had learned the obvious necessity of setting stop losses and keeping an ear to the market-sentiment ground when things looked shaky.

Sometimes learning lessons is a cop-out. When you're scraping the blood off your knees, it might feel good to ask what you can do next time to avoid the chipmunk running in front of your bike. It feels even better to think for a few weeks and conclude that the problem was that you'd been biking the day after a full moon smack in the middle of chipmunk mating season.

Unfortunately, rational and intuitive hypotheses are not good substitutes for being right, and it takes a lot more than a rational hypothesis to be right about a lesson to be learned from the movement of the market. If it's even possible at all, it takes extreme rigor. There are 8 million intelligent-sounding hypotheses in the naked city, but almost all of them are dead wrong. You'd generally be a lot better off sticking with the information that wasn't derived from your relatively anecdotal experience, and dropping your chipmunk theories altogether. Because the kind of rigor that it requires to even have a chance to compete with the professional theory miners is, well, pretty rigorous.

Take a step back
Don't worry. This isn't a feel-good "take a step back from the market, kiss your pet bird, and watch the sunset" observation. It's more of a "don't measure the elephant by staring at only its trunk or its tail" observation.

Since March of this year, the Nasdaq Composite has clearly taken a dramatic hit. In fact, the 43%+ drop in that time is the second biggest drop ever in the Composite, behind only the near-60% drop in the 1973-74 market. Even bigger than the '87 crash. That's what it looks like from up close: a bear of a bear market. It's tempting to feel like the Nasdaq today is the equivalent of the broader markets in the early 1930s, begging for brave investors to be rewarded for accumulating at the bottom. But, take a step back.

Here are some of the major milestones the Nasdaq has hit since its inception in 1971, including the dates it closed over the benchmark for the first time.

Date                Milestone  
02/08/71               100
11/13/80               200
04/12/91               500
07/17/95              1000
07/16/98              2000
11/03/99              3000
12/29/99              4000
03/09/99              5000

It doesn't take a hard look to see that it took the Nasdaq a plodding 20+ years to get its first quintuple, but only 4 1/2 to pull off its most recent five-bagger. If you take today's composite close of 2871.45, it turns out that since that first quintuple in April of 1991, the Index has returned 19.93% annually over the last decade. That's after the 43%+ drop of this supposed bear market and well above the Nasdaq's 8.3% annual increase in its first 20 years and the broader market's historical nominal return of around 12% (ignoring the relatively small Nasdaq dividend yield). That's especially impressive considering that inflation has averaged around 2.6% or so over the last 10 years, meaning real rates of return have been incredible. Welcome back the bull market, because it still hasn't left.

Let's say the Nasdaq never had this bear market, but instead steadily returned 12% nominally -- around the historical nominal return of the broader markets -- from different points in time. Where would it be today?

 

Date          Level          Today's Level
02/08/71       100               2912.30       
11/13/80       200               1929.26
04/12/91       500               1501.01
07/17/95      1000               1633.48
07/16/98      2000               2604.40
Actual Value                     2871.45

 

So, for the past 20, 10, 5, and 2 1/2 years, the Nasdaq has, even excluding dividends, provided "bull marketesque" nominal returns. If the Nasdaq had only grown at 12% from its all-time low close of 54.87 in October of 1974, it would be sitting at a lofty 1179.77 today. So, even if it dropped another 43%, it'd still be ahead of what you might have predicted in 1991 had you expected typical performance over the next 10 years.

Obviously, I'm not trying to say the Nasdaq is going to get cut in half again. I have no clue where it'll be in 12 months. I'm just saying that its historical position wouldn't look absurd if it did, and that it's dangerous to think you're sitting in the middle of a bear or contrarian market when it's exactly the opposite with a longer timeframe of mind. Most important, I think it's extremely ineffective to base investment decisions -- either panic or optimism -- on a snapshot perception of recent market movement.

Unless you're relying on some seriously researched information, I would say the only thing worth learning from this torrential market is that it isn't really a torrential market, and the meaning of risk tolerance is defined by your stomach, not a piece of paper.

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