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Don't Blame Tesla or Netflix for the Next Dow Crash

By Dan Caplinger – Feb 26, 2014 at 12:30PM

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Many think that high-momentum stocks are signaling a bubble. But the next crash won't be for any such obvious reasons.

Major U.S. stock indices were rising Wednesday to continue their strong February, with the Dow Jones Industrials (^DJI -1.03%) gaining 45 points as of 12:30 p.m. EST. With this bull market approaching its fifth birthday, many investors are nervous about how much longer stocks can keep soaring -- and some point to huge parabolic moves upward for high-profile stocks Tesla Motors (TSLA -1.44%) and Netflix (NFLX -2.25%) as a sign that the end is near. Yet while froth in the market is often a troubling sign, we've learned from past bear market events that when the bull market finally ends, it'll be for reasons that few people can predict -- and that will in all likelihood only be clear in hindsight.

What history tells us
It's true that in the past, cataclysmic market crashes have always come after periods of what former Federal Reserve Chairman Alan Greenspan liked to call irrational exuberance. During the tech boom, investors stopped worrying about the fundamental business prospects of emerging Internet stocks, instead creating new measures that they believed could justify their rising valuations. Similarly, during the mid-2000s, investors in financial companies concluded that growth in the housing market could continue at what proved to be an unsustainable pace, and when the bottom fell out of housing, bank stocks followed suit.

In that context, it's easy to see skyrocketing share prices for Tesla, Netflix, and other high-flying popular companies as signifying the end of the bull-market run. But the reality is that these and other stocks can move in and out of favor without necessarily having any impact on the broader market.

Netflix is the most obvious example of this phenomenon. Shares of the streaming-video giant hit $300 in mid-2011, and market cynics raised the same arguments about how only a frothy stock market could support such a stratospheric rise in an untested company. Yet when the stock subsequently lost three-quarters of its value, it didn't do anything to stop the rise in the Dow Jones Industrials.

Tesla hasn't had quite the history of ups and downs that Netflix has, but you can see similar patterns in its recent moves. Early last fall, Tesla lost a third of its value as some questioned whether the company could sustain fast enough growth long enough to justify its skyrocketing valuation. During that span, the Dow gained ground -- albeit with some volatility -- and its returns generally weren't correlated to Tesla's returns from day to day.

Moreover, the same thing could be said for other stocks that have already given up some of their gains. Apple (AAPL -2.54%) still hasn't come close to recovering all of its lost ground, yet even as the largest stock in the market, its drop hasn't held the bull market back. If a stock the size of Apple can't trigger a Dow crash via underperformance, it's hard to think that smaller stocks could.

Hindsight is perfect
Rising valuations for Tesla, Netflix, and other strong stocks are indeed worthy of notice, and when the stock market does experience its next major correction or crash, investors will inevitably remember their impressive performances and wonder if they contributed to the plunge. But seeing those story stocks shouldn't keep you from sticking with your investing strategy, because just because they're flying high now doesn't mean that when they fall -- if they fall -- they'll necessarily take the whole stock market with them.

Dan Caplinger owns shares of Apple. The Motley Fool recommends Apple, Netflix, and Tesla Motors. The Motley Fool owns shares of Apple, Netflix, and Tesla Motors. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$33,596.34 (-1.03%) $-350.76
Apple Stock Quote
$142.91 (-2.54%) $-3.72
Netflix Stock Quote
$305.56 (-2.25%) $-7.03
Tesla Stock Quote
$179.82 (-1.44%) $-2.63

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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