The Formula to Spot a Bubble

Mark Hulbert has an interesting column at MarketWatch. It’s about a trio of academics who have devised a bubble-spotting formula.

Applying the formula the researchers derive, I calculate there is an 80% chance that the Technology Hardware, Storage & Peripherals index will be 40% lower than today at some point in the next two years. Among some of the better-known firms in this industry are Apple (ticker: AAPL), Seagate Technology (STX), and Western Digital (WDC).

Though no other industries satisfy the researchers’ definition of a bubble, two others come close. They are also in the technology arena: Semiconductors and Semiconductor Equipment, and Software.

Why focus on an industry that may be in a bubble, rather than the market as a whole? Prof. Greenwood told Barron’s that he and his fellow researchers learned from their study of the history of bubbles that they “rarely are marketwide” events. Far more common, he said, is for a bubble to manifest in certain pockets of the market even as other sectors remain undervalued.

So what do they look for?

The researchers define a bubble to be any industry whose two-year return is at least 100 percentage points greater than the overall market’s. This is a high standard indeed—among all industries for which they had performance data between 1926 and 2016, just 40 satisfied the definition at any point over this 90-year period.

Not all bubbles burst, of course, and those that do don’t always burst right away. The researchers imposed a strict precondition here as well: Once an industry satisfied their definition of a bubble, they considered it to have burst if, within the subsequent two years, it lost at least 40% of its value. Of the 40 industries that satisfied the researchers’ definition of a bubble, 21—or 53%—burst.

Posted by on February 17th, 2021 at 3:23 pm


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