NASDAQ 100 (NDX) – Positive Transit of EBV+5


Friday, October 18, 2013 was an historic day in the financial markets.  The NASDAQ 100 Index, a modified capitalization-weighted index, of the 100 largest traded companies on the NASDAQ had a positive transit of EBV+5.

Here is our short-term model price chart of the NASDAQ 100 Stock Index confirming the breakout.

NASDAQ 100 Index (NDX) with weekly price bars and EBV Lines (colored lines).

NASDAQ 100 Index (NDX) with weekly price bars and EBV Lines (colored lines).

As a reminder, I have republished our long-term model price chart of the same index using monthly bars and going back to 1995 – some 18 years.

NASDAQ 100 Index (NDX) with monthly price bars and EBV Lines (colored lines).

NASDAQ 100 Index (NDX) with monthly price bars and EBV Lines (colored lines).

Observables from our model price charts.

1.  Looking at the history of valuation of this index, especially in the late 1990’s and much of 2000, the NDX Index has always traded above EBV+5.  During the financial crisis of 2008, you can see the index had a negative transit of EBV+5 bottoming at EBV+3.

2.  Over the last 5 years the Index tried, without success, to transit above EBV+5.  (See arrows on our long-term model price chart)  EBV+5 was a barrier or resistance that collectively these companies could not transit.  Hopefully readers can see the significance of this transit and the struggles this particular Index has had to achieve this transit over the last 5 years.

3.  The other observable is where this index topped out in 2000.  Yes, this index topped out at EBV+9.  Just for fun EBV+9 in today’s terms for the NASDAQ 100 Index would be 17,369.  Four times what the index is trading today.  I not saying we are going there again anytime soon, but at least for reference purposes you can see what valuation level this market achieved in the past.

What is so important about EBV+5?

In Model Price Theory (MPT) every EBV level has a history and a story.  Some EBV levels are more significant than others.  EBV+5 is significant.  At this valuation level and above, companies are given a special valuation by the market.  These companies have, what we call ‘Economic Velocity’.  ‘Economic Velocity’ is a state an individual company is in, that the market recognizes, is operating or has the ability to operate at full potential.  The wind is at the company’s back, proverbially speaking.  Everything the company does in the interaction with its customers and suppliers – it business process – is easy and massively profitable.

Another way of looking at this valuation level is the equity markets are giving the company market value or an asset for management of the company, through its share price, to use to grow the enterprise.  Equity capital can be used by management, either issuance of shares or by way of acquisition, at relatively cheap cost to further their business process or strategy to promote even faster growth than what management is already getting.

EBV+5 Plus Convexity Equals Substantially Higher Equity Valuations

All market participants, at one time or another, have observed parabolic or positive dramatic momentum moves in stock prices.  Many market professionals simply observe these phenomena without a general understanding of why these stock moves exist.  Others like George Soros, have a better understanding of this phenomena and have given these market moves a name like ‘reflexivity’ but cannot give mathematical reasons why these moves exist.

Model Price Theory (MPT) has captured, mathematically, the preconditions, and adjustment process to capture this dynamic feedback mechanism that exists between the balance sheet of a public enterprise and the public market equity price of the company in question to determine the model price or our calculation of fair market value for the company.  We call this dynamic feedback mechanism and mathematical variable ‘Convexity’.  We believe ‘Convexity’ is an appropriate name in that the mathematical relationship is a convex one.  The greater the convexity, or bend, the greater the sensitivity the Economic Structure Value (ESV) has to changes in its stock price.  Or simply, the smaller the company’s balance sheet is relative to the public market value the higher the ‘Convexity’ variable of the company.  The higher the company’s ‘Convexity’, the higher the dynamic feedback mechanism as the company’s stock price goes higher.

It should be said ‘Convexity’ has a dark side as well.  As a company’s stock price falls this dynamic feedback mechanism can work in the opposite direction.  That’s why the ‘Technology Crash’ of 2000 was swift and just as fast as the ride up in share prices, making the boom – bust symmetrical in appearance on a log scale.  (See our long-term model price chart)

For those who are lost on this discussion, no problem!  Our Model Price calculation has ‘Convexity’ mathematics included in our algorithm.  ‘Convexity’ is one factor in our three-factor model that we use to calculate model price.

I only bring the ‘Convexity’ subject up, because of the importance of the positive transit of EBV+5.  ‘Convexity’ becomes more relevant factor and help boost share valuation significantly when ‘Convexity’ and share prices work in tandem elevating share prices ever higher.

Conclusion

The NASDAQ Index has been on a tear over these last few months culminating in a positive transit of EBV+5.  This is very positive for the US equity markets and adds another positive to the growing list of positives this equity market and the US economy has achieved over the last 5 years since the financial crisis of 2008.

Another aspect of this blog I wanted to review with my readers is the impact of ‘Convexity’ can have on valuation.  Like stored up energy, ‘Convexity’ has been a non-factor since 2008 and lays in wait to positively impact valuation like a turbo boost in a European sports car.  Having the NASDAQ 100 (NDX) Index transit positively over EBV+5 certainly is a pre condition of allowing ‘Convexity’ to play a larger role in valuation of a company.

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