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How To Play With Stock Market Bubbles

Today’s S&P 500 and Nasdaq trend bears a striking relationship to the Dot-Com era. But that’s not bad news.

I remember this like it was yesterday, even though it was 20 years ago. The stock market, which had been in rally mode for years, took on a superhero-like status with investors. Everyone was getting rich. Well, that’s what they told you, anyway.By the end of 1999, the “market” was in great shape. The S&P 500 went up nearly every day. And, there was this new buzzword among those new to investing: Nasdaq!The Nasdaq Composite Index, and particular the top 100 companies on that stock exchange (aptly named the Nasdaq 100) were all about the “in” companies of the new, tech-driven economy. They were get-rich-quick schemes, but with one key difference. They worked!

Nasdaq fever is back

For those who don’t remember, or were too young to remember, here is the path taken by the S&P 500 and Nasdaq 100 indexes from the start of October 1999 through the end of March 2000.Yes, you read that decimal on the purple line correctly. The Nasdaq 100 rose by 82% in 6 months. The S&P 500 was “only” up 17% during that time.

When does 2020 = 2000? Now?

Now, most of those moves occurred in late 1999. The first quarter of 2000 was more like the “after-burners,” as experienced market participants were joined by speculators…lots of them. And, while the S&P 500 had a very pedestrian gain of 2.4% in that first quarter of 2000, the Nasdaq added to its amazing late-1999 run by accelerating another 20% in that quarter.

Nothing to see here…except a deja vu moment

Now, fast-forward to today. Since October, below is the path of the S&P 500 and Nasdaq 100. The Nasdaq is showing signs of that same “breakaway speed” that tends to accompany the furious moves that finish off long bull markets. It happened in 2000, it happened in 2008, and it appears to be happening today.The key issue for us is how to treat this in the context of our overall portfolio strategy. After all, this was a pretty normal bull market cycle until early 2016, when the Fed pumped massive liquidity into the financial system. Loose monetary conditions can get you pretty happy, in the way that happy hour at a bar encourages folks to drink more than they might otherwise do.That continued with only temporary pullbacks. Then, late last year, the monetary pump was cranked up again. The result is a market environment with minimal fear, where “buy the dips” is still the law of the land. This is especially true when it comes to the tech sector, and the narrow group of giant companies that drive both the Nasdaq and S&P 500 these days.

When the headlines don’t tell the whole story

And that brings us to one more picture from late 1999 and 2000, shown below.In that remarkable 6-month period covering the last quarter of 1999 and the first quarter of 2000, the Technology sector of the S&P 500 rose by nearly 50%. But as with the market the last few years, it was a case of the headline indexes masking severe under-performance by certain sectors. As you see above, Consumer Staples, Materials and Utilities stocks were all down between 3-10% in that period.The result of such lopsided performance is that it creates bubbles. The bubbles are in stock prices, consumer confidence, government spending, and the service part of the economy. The manufacturing sector is weakening, and debt is out of control, and getting worse by the day, literally.

Strategy time

But for now, none of this matters. Frankly, as it nearly always the case, my chart work has been the best guide. The Nasdaq/Tech sector obsession probably has more life to it. But the similarities to the year 2000 have caused me to access that historical anomaly in different ways. After all, in my world, risk management is always queen and king.Specifically, getting equity exposure to Technology and the broad indexes in general can be done in many ways. You can buy the stocks, you can buy funds that own the stocks, or you can buy call options on the major market indexes. There are even some ETFs that provide a combination of preservation investments and call options on the major market indexes, so you can get both in one package.You can take one of those routes, or you can take them all. Just keep in mind that regardless of how you choose to participate in this Tech-led, Dot-Com bubble-ish environment, be sure to think steps ahead.After all, in the year 2000, past the end of the charts I showed you above, it was not pretty. There has never been a better time to be a careful, hedged investor.

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