There’s still a risk jumping on Nasdaq bandwagon

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I still remember it vividly. It was a cold February night in the year 2000. I had just finished a presentation about RRSP investing to an audience in St. Catharines, Ont., and was chatting with some of the attendees over coffee.

A woman who appeared to be in her late 50s or early 60s asked if she could have a word in private. We moved to a quiet corner where she explained her dilemma. She had worked all her life at an office job. She had no pension plan and no real savings apart from her RRSP. She was concerned the value of the plan was not increasing quickly enough to provide her with the retirement income she would need in a few years.

What did I think, she asked, about the idea of switching all the money in the RRSP into a Nasdaq index fund? The Composite had been posting spectacular gains, and she saw this as a way to dramatically improve the returns on her retirement fund.

I strongly urged her not to do it. I explained that Nasdaq was top-heavy with technology stocks, which had been fuelled by investor frenzy over the rapid expansion of the Internet. While I shared the excitement about the Internet's potential to change our lives, I told her I felt the stock valuations were too high and that whole situation looked like a bubble.

She did not seem to be convinced by my arguments. She could think only of all the money other people seemed to be making while her retirement savings plodded along. She wanted a game-changer.

I never heard how the story turned out. I only know that within weeks the Nasdaq Composite began its long plunge from the record closing high of 5,048.62 on March 10 all the way down to 1,114.11 in October 2002. That drop of 78 per cent put what became known as the dot-com bubble on a similar scale to the Crash of 1929. Losses topped $5-trillion (U.S.), a sum that would have included a large chunk of the retirement savings of the lady from St. Catharines if she went ahead with her plan.

Many fledgling Internet companies disappeared entirely including what were then well-known names like Pets.com, Open.com, and Startups.com. Others saw their stock prices shattered, although they later recovered and are thriving today. That group includes eBay, Cisco Systems, and Amazon.com.

At the time, I wondered if I would ever see the Nasdaq Composite back over 5,000 in my lifetime. We already had seen the collapse of Japan's Nikkei Index, which to this day has not regained the heady levels it reached in the early 1990s. Nasdaq looked like a similar situation.

Well, it took almost 15 years but last week Nasdaq finally poked its head above the 5,000 level once again, if only for a short time. Like the groundhog that saw its shadow, the index seemed spooked by such rarefied atmosphere and promptly retreated, finishing the week at 4,927.37.

The index has changed a lot since the crash. It's still tech-heavy but much less so than back in the late 1990s. The companies that dominate now are hugely profitable, growing, and cash rich – names like Apple, Google, Microsoft, and Cisco. There are a lot more health care stocks in the mix (Akorn Inc.), biopharmaceutical companies such as Gilead Sciences, transportation stocks (American Airlines Group, Atlas Air Worldwide), and industrials (Arctic Cat). It is in some ways a different Nasdaq.

But the high-tech dominance is still there and even though it has become more diversified over time the future course of the Nasdaq Composite is still closely tied to the fortunes of big technology. There is particular concern right now about the biotech component, which comprises 11.2 per cent of the Composite's weighting making it the largest single sector. A Bloomberg report published on Friday noted that short interest in the Nasdaq Biotechnology Index has doubled since 2013, suggesting that many investors see it as a bubble that's about to burst. That wouldn't result in a plunge on the scale of 2000-2002, but it wouldn't be pretty.

That said, the overall outlook is more stable than it was back in the Wild West days of the late 1990s when anyone with an Internet idea could attract millions in start-up funding. Information technology is now a core element of every business, on-line retailing is driving some conventional stores out of business (think of booksellers), e-mail and Skype have fundamentally changed the way we talk to one another, and on-line streaming is challenging the whole business model of television and movie distribution.

So could we see another Nasdaq crash like the dot-com plunge? It's not likely given the strength of the index's most heavily weighted companies. However, it can't be ruled out. Apart from a possible biotech bubble, the main threat as I see it is a massive cyber terrorist attack that would cripple the worldwide net for an extended period, with severe financial repercussions for the economy generally and technology retailers in particular. That certainly cannot be ruled out – we have already seen the economic impact on business of relatively small-scale attacks such as North Korea's hacking of Sony and the data breach at Target.

A report released last week by the Fraser Institute highlights the growing danger of international cyber attacks. Co-authored by Alan Dowd, Alexander Moens, and Seychelle Cushing, the report warns that "states with a well-developed capability for cyberattacks…pose the greatest danger to national and economic security. These adversarial states possess the ability to execute sophisticated and unrelenting cyberattacks."

The report notes that it is difficult to obtain precise estimates on the costs of such attacks to business but says they could run to hundreds of billions of dollars.

This means that anyone thinking of jumping on the Nasdaq bandwagon now needs to consider the risk factor carefully. A meltdown on biotech or a massive Internet attack would certainly result in a big drop in valuations. But even if we dodge that bullet, don't lose sight of the fact it's always dangerous to buy any security when it's near an all-time high. There's bound to be a correction, usually sooner than later.

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