The Nasdaq: What A Drag!

The April dip was for fools. Were you one of them? If so, you had plenty of company. For most of a decade, investors have enriched themselves by plowing money into the market every time it stumbled. Whatever the downward catalyst, from Yeltsin's coup to the Asian flu, prices routinely rebounded.

But that behavior defied a bedrock principle that the market makes most people look silly most of the time, a principle that quietly resurfaced last spring in the form of a dotcom massacre and today presses squarely in the face of eternal bulls. As has been fairly obvious for most of human history, not all market pullbacks are buying opportunities.

We may be getting close to a blue-light special now. Maybe. Remember, though, that bargain hunting around the March-May sell-off rewarded only a few while ravaging many. Electric utilities, oil and some financial and left-for-dead health-care stocks have done well. But that's not where the money was. Popular techland has been a disaster. Last week the NASDAQ yo-yo busted its string and fell to a new low for the year, extending a slump in the most speculative stocks and grounding the likes of Intel, Dell, Cisco and Lucent.

Some brokerages were poised to send out margin calls early this week, though a rally Friday may have provided a reprieve. Many investors, it seems, became so convinced that prices were cheap last spring that they doubled up, partly with borrowed money. Now lots of stocks are even cheaper. The NASDAQ bottomed at 3165 on May 23, suckered in a wave of new money with a 1,000-point rally, then collapsed in stunning fashion--closing as low as 3075 on Thursday. From the March 10 peak of 5049, the index dropped 39%. In the 17 trading days ending Friday, the NASDAQ closed lower a numbing 14 times.

Those numbers only begin to address the carnage. The average NASDAQ stock is down 48%, more even than during the 1987 crash, reports Salomon Smith Barney. Thanks to relative strength in more conservative stocks, broader market measures haven't been as devastated. Still, the Standard & Poor's 500 hit a new low Thursday, bringing its decline to 13%, and the Dow, while still above its spring low, was off 14% from its high nine months ago.

Such declines skirt the boundaries of an official bear market, commonly defined as a drop of 20% or more. But for most investors, this is indeed a bear. In their next statement, millions of 401(k) and mutual- fund investors will see net-investment losses and possibly a lower balance for the second consecutive quarter.

The investing backdrop hasn't been this frightening since 1990. An eroding wealth effect could hurt consumer confidence, while a surging dollar is taking a bite out of the earnings of U.S. multinationals. Among companies sending up earnings flags: Home Depot, Yahoo, Lucent, Intel, Kodak, Dell and DuPont. Meanwhile, renewed hostilities in the Middle East are pushing oil prices higher, threatening to stoke inflation.

In retrospect, of course, 1990 was a great time to be loading up on stocks. Since a bear market ended late that year, the NASDAQ has risen 10-fold and the Dow more than fourfold. Whether the next decade will prove as profitable is an interesting question but one that, frankly, can't be answered. Long-term investors can take comfort in knowing that the overwhelming odds are for stocks to be higher a decade from now. But that doesn't help much in times like these, when all you really want to know is whether the bloodletting is nearly over or just getting started.

Wall Street seems equally divided on the issue. "There is more ugliness to come," asserts Stan Nabi, chief investment officer at DLJ Investment Management, who notes that many tech stocks still trade way above the prices warranted by their earnings power. One common measure of value compares a company's projected annual growth rate with its current price-earnings ratio. If the P/E is lower, the stock may be attractive. A lot of tech stocks will grow earnings 35% a year in coming years but have P/Es way above that. Cisco, for example, trades at 148 times trailing earnings even after the stock has sunk 34%.

Vince Farrell, chief investment officer at Spears Benzak Salomon & Farrell, worries that fund managers have a lot more tax selling to do, looking to realize losses to offset gains they took early this year. "You don't give the client a negative return and a tax bill in the same year if you can help it," he says. The stocks most likely to come under further pressure are the big liquid names, the Ciscos and Microsofts. Tax selling by individuals may barely have started. They tend to hold losers into November hoping for a rebound, and then sell if one doesn't materialize. "I haven't been dipping in yet," says David Schafer, manager of the Strong Schafer Value Fund. "This is a time to sit back and assess the damage."

On the plus side, tax selling must halt by year's-end. Many believe the Middle East issues won't force oil prices much higher and oil could retreat modestly fairly soon. Despite the many earnings warnings, overall corporate profits will be up about 15% this year and 10% more next year. Largely ignored last week were solid results from PC maker Gateway and optical-networking company Corning.