WHY THE NASDAQ LOOKS UNDERVALUED RELATIVE TO THE NYSE -- THE NASDAQ IS BEING LED HIGHER BY APPLE, CISCO, AND MICROSOFT

A VISUAL COMPARISON WITH THE NYSE ... On Wednesday, I wrote that the Nasdaq market could start doing better than the broader market. The main reason simply has to do with the fact that the Nasdaq is cheap relative to NYSE issues. Chart 1 is a simple visual comparison of the Nasdaq (monthly bars) and the NYSE Composite Index (solid line). While both markets usually trend in the same direction, the magnitude of those trends has differed. The Nasdaq fell much more than the NYSE from 2000 to 2002. But the NYSE has risen much further than the Nasdaq since 2003. In my view, that makes the Nasdaq undervalued relative to the NYSE. The comparison is more easily made with a relative strength ratio.

Chart 1

NASDAQ/NYSE RATIO MAY BE BOTTOMING ... Chart 2 is a ratio of the Nasdaq Composite Index divided by the NYSE Composite Index. Ratio charts can be analyzed like any other chart. That means that they have support and resistance levels and move in discernible trends. The ratio collapsed from 2002 to late 2002 as the Nasdaq badly underperformed the NYSE. The ratio bottomed in late 2002, however, and rose to the end of 2003. That means that the Nasdaq actually led at the start of the current bull market. The ratio has fallen for the last three years as the Nasdaq has underperformed the NYSE. Notice, however, that the ratio is bouncing off chart support at its late 2002 low (green arrows). It still needs to break its 2004-2006 downtrend line to confirm an upturn. But there are already signs that the ratio may have bottomed. Chart 3 is a point & figure version of the Nasdaq/NYSE ratio. It's been on a p&f buy signal since September.

Chart 2

Chart 3

NASDAQ LEADERS AREN'T THE OLD DOT.COMS... At least one of our readers expressed skepticsm about the prospects for Nasdaq leadership because of the 2000-2002 meltdown of "bankrupt dot.coms". The good news is that this Nasdaq rally isn't being led by small dot.coms. It's being led by large, blue chip technology stocks. Three examples are shown below. Chart 4 shows Apple Computer on the verge of a new record high. It broke through its 2000 peak a year ago. Its relative strength line (measured against the Nasdaq) has been rising since 2005. Chart 5 shows Cisco Systems climbing to a nearly three-year high this month. The big network stock is nearing a challenge of its early 2004 peak at 29.39. Its relative strength ratio (vs. the Nasdaq) bottomed a year ago and has been rising all year. [Notice that the Cisco/Nasdaq ratio bottomed in late 2005 near the lows formed during 2001 and 2002]. Chart 6 shows Microsoft breaking out to a new five-year high. Its RS ratio shows that MSFT has been a Nasdaq underperformer for the last four years. Its been leading the Nasdaq higher for most of this year. The fact that the Nasdaq is being led higher by such high-quality large caps is a good sign for that market. Some other large and well-known stocks that have been leading the Nasdaq higher recently incude Amazon, Celgene, Comcast, Ebay, Electronic Arts, Ericcson, Google, Juniper, Nvidia, Paccar, and Research in Motion. Those aren't exactly "fly-by-night" organizations. The Nasdaq 100 has risen even faster than the Nasdaq Composite Index since August which is another sign of large-cap technology leadership. Both indexes, however, still need decisive closes at new 52-week highs to confirm a bullish breakout.

Chart 4

Chart 5

Chart 6