Shares of companies across the entire US stock market have recently been on a tear, increasing sharply. Could this be an indicator that the stock market is due for a downturn?
Unfortunately, no. But that doesn’t mean our nation’s markets don’t have massive potential.
Just look at the stocks that have bucked the trend recently, like Abiomed and Celgene. Of the 10 best-performing big-cap stocks last year, nine were biotech. Another biotech giant, Novo Nordisk, was No. 2. Even Apple comes in at No. 4 in this list, faring better than the rest of the big-cap stocks.
So why are these stocks performing so well? Why are the financial markets sizzling right now?
In some ways, such a beating is just par for the course. During extended bull markets, momentum stocks tend to outperform more staid industry peers and lag behind the market.
Sometimes it’s because the company has an extraordinary future — Apple and Amazon, for example, started from smaller bases and achieved stratospheric valuations. They rode consumer demand to a profit and sat back on the sidelines, waiting for future growth to bring their shares down to earth.
Others times, it’s because the company has a relatively unsophisticated management team. Another firm in this list, Futon Technologies, just went public and crashed more than 70% from its opening price — never the business model for success.
Mostly, however, there is a simple reason why companies in these fields continue to thrive when the economy is expanding. Every year since 2007, biotech has produced an average return of about 40% per year in the NASDAQ. This performance ratio is nearly 10x higher than the overall NASDAQ return.
A bubble only happens if there’s strong demand. And there’s no evidence that Wall Street’s investors are seeking out safer places for their money.
The aforementioned rocket-ship tech stocks illustrate why this country’s stock market might be due for a correction — for years, it’s been sailing like a butterfly, doing fine in a turbulent market, but getting hit hard when it’s not. In fact, the markets have never run up so fast, yet performed so poorly. This is no longer the calm before the storm, but the storm.
It’s not a good time to be an investor, but it won’t be a lot of fun during a correction, either. The overwhelming majority of investments go down during recessions. Worse, they tend to stay down for a long time.
That’s because stocks have historically traded at low prices during severe recessions and recoveries. A poor economic performance marks the end of a business cycle, and investors tend to interpret that as a sign of a poor long-term outlook.
But when you dig in to the causes of the downturns, you’ll often find a long decline of hard-hit companies wreaking havoc on the market. Looking back at the 30-year period between 1980 and 2000, there were a total of three recessions. The only year when stocks rose more than 30% was 2001. And in 1991, the NASDAQ plummeted by more than 50%.
Those recessions are the best evidence we have that the stock market’s prices are crazy low right now. The damage has been so severe that a simple simple metric can’t even capture it.