What to expect during stock market bubbles?
There are at least 5 stock market bubbles today, according to Ruchir Sharma, chief global strategist of Morgan Stanley (via FT). Here’s where:
- Cryptocurrencies, including Bitcoin and Ethereum.
- Clean energy stocks, including electric vehicle companies.
- Small-cap stocks (i.e. companies with $300m-$2b in market capitalization).
- Tech stocks with rising share prices that aren’t supported by earnings.
- 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.