Wrapping up a rather dismal 2022 for major stock indexes, this post will look at what happened with the S&P, Dow, and NASDAQ and where they all stand going into 2023. In my previous posts I looked at the long term trends for each index. You can review the post for the S&P here, the DOW here, and the NASDAQ here. The long term price trends for each of the indexes almost perfectly follow an exponential growth curve and are predictable over the long term. On a short term basis, the indexes are always either overvalued or undervalued with ongoing upward and downward corrections.
Focusing on 2022 weekly price data vs. the long term trend line shows that all three indexes were in an overvalued situation at the start of 2022. The least overvalued was the Dow:
The red line is the "line of best fit" to the data. The trend line is a straight line because I applied a log transformation to convert the exponential trend to linear. On 1/2/22 the trend line suggests a LN(price) fair value of 10.427 which equates to $33,781. The actual value was 10.497, or $36,231. As 2022 progressed, the price fell below the trend line to a low of $28,730 on 9/25/22. The last data point of the year on 12/26/22 shows the price of $33,147 vs. the trend line fair value of $36,503. The index sits about 10% below fair value. The Dow performed better than the S&P and NASDAQ because it was only slightly overvalued at the start of 2022 and fell to slightly undervalued.
Looking at the same analysis for the NASDAQ:
Compared to the Dow, the NASDAQ was extremely overvalued at the start of 2022. The LN(Price) was 9.61 vs. the trend line value of 9.26. This equates to a price of $14,935 vs. the fair value of $10,513 (142% overvalued). Based on the long term trend analysis, this scale of overvalue is not sustainable and must correct downward. And so it did throughout 2022, ending at $10,446 on 12/26/22 vs. the trend line of $11,561. The NASDAQ ended about 10% undervalue, similar to the Dow.
The same analysis for the S&P reveals similar results:
Like the NASDAQ, the S&P was also severely overvalued at the start of 2022. On 1/3/22 the LN(price) was 8.45 vs. the trend line of 7.99. This equates to the actual price of $4,677 vs. fair value of $2,968. This is a whopping 57% overvalue. Based on the long term trend analysis, this scale of overvalue is not sustainable and must correct downward. Like the NASDAQ, the S&P fell throughout 2022, ending at $3,839 on 12/26/22 vs. the trend line of $3,166. Unlike the Dow and NASDAQ, the S&P still appears overvalued at the end of 2022.
Overall, investors should be well positioned in the NASDAQ or the Dow headed into 2023. I would be wary of the S&P since it still appears overvalued and could decline further. What caused the overvalue situation at the start of 2022 is open to debate. A common explanation for the downward correction throughout 2022 was the problem of inflation and the action of the FED. Keep in mind that from a purely mathematical perspective, the overvalued state was not sustainable and a correction must occur back to the trendline or below. The mechanism through which is correction occurs is somewhat irrelevant.
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