Are We In A Stock Market Bubble?Submitted by S. F. Ehrlich Associates, Inc. on March 31st, 2017
March 31, 2017
The market’s recent gains since the presidential election have led some investors to conclude that we must be approaching a market bubble. Mark Hulbert, writing in Barron’s1, says “Not so fast.” A recent academic paper2 defines a bubble “as a price increase of at least 100% over a two-year period followed within the subsequent two years by a drop of at least 40%.” By that definition, there have only been two bubbles in our history: the market that peaked in 1929, and the dot-com bubble that peaked in 2000.
When the researchers broadened their definition to industries (i.e., the coal industry), they found 40 occasions since 1928 in which an industry rose 100% over a two-year period and then collapsed by at least 40% over the following two years. But even using criteria used for an industry bubble (i.e., volatility), there are currently no flashing warning signs in our opinion.
None of this means that the markets won’t fall over the next month/year/years, only that there’s a significant difference between a bear market and the bursting of a bubble. Says Hulbert: “And on that score, at least, it appears that investors can breathe more easily.”
So are the good times here to stay? “Humans are hardwired to believe they can rely on the recent past to predict the future. As investors celebrate the eighth birthday of a bull market, that’s a dangerous tendency.” The remainder of the article in FORTUNE, titled “Beware of Happy Memories”, cautions investors against recency bias, which occurs when investors believe the recent performance of the market will continue into the future.
Of course, we all know the good times may continue, but just because something has happened doesn’t mean it will continue to occur. Every day is a new day in the stock market, with only a slightly better chance that the market will go up that day as opposed to going down. But the fact that we’ve had an eight-year run doesn’t mean that run is unencumbered. Citing the oft-used expression, ‘trees don’t grow to the sky’, this bull will end; we just don’t know when.
1 Hulbert, Mark. “Are We in a Stock Market Bubble.” Barron's, 27 Mar. 2017.
2 Greenwood, Robin, Andrei Shleifer, and Yang You. "Bubbles for Fama." NBER Working Paper Series, No. 23191, February 2017
3 Taylor, Chris. “Beware of Happy Memories.” Fortune, 1 Mar. 2017.