What to expect during stock market bubbles? - The Average Joe

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    What to expect during stock market bubbles?

    victorlei

    June 17, 2021

    There are at least 5 stock market bubbles today, according to Ruchir Sharma, chief global strategist of Morgan Stanley (via FT). Here’s where:

    1. Cryptocurrencies, including Bitcoin and Ethereum.
    2. Clean energy stocks, including electric vehicle companies.
    3. Small-cap stocks (i.e. companies with $300m-$2b in market capitalization).
    4. Tech stocks with rising share prices that aren’t supported by earnings.
    5. Special Purpose Acquisition Companies (ELI5: SPACs).

    Sounds like old news? The bubble surrounding many of these stocks have already popped. But the question is: how much lower can they go?

    Tell me why, Sherlock: Clues of a bubble include excessive trading and borrowing, and earnings (or rather, a lack thereof) that don’t justify the high prices.

    Hint: If prices rise by over 100% in a single year and the majority of that increase happens in the last few months, call Watson.

    And what happens after? Sharma’s model shows two cases:

    • If the sector fell 25-35%, they historically moved back up afterward but at a slower pace.
    • If the sector fell 35%+, things were only downhill from there. In this case, stocks would bottom at 70% (median), ~2 years after.

    Give me some examples: In the following cases, these industries fell over 70% and took over a year to find their bottom.

    • The crypto market crashed in Dec 2017 and didn’t reach its bottom until Mar 2019.
    • The cannabis market crashed in Mar 2019 and didn’t reach its bottom until Oct 2020.

    With the exception of small cap stocks, today’s bubbly sectors have declined 35-50% in recent months. If history repeats itself, we might not see these sectors move up for a while. And there’s always the chance we’re not even at the bottom yet.

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