When Will The Next Bubble Pop And Which Market Will Suffer?

by: Louis Navellier

The sun is shining, Europeans (and some Americans) are on vacation, but the press continues with its downbeat drumbeat - daily news about all the things that can go wrong in the world and in the markets.

Take your pick: Will we suffer from a "bond bubble" popping as interest rates rise and investors switch from bonds to stocks? Or will the stock market soar to unsustainable heights, as in 1987 or 1929, leading to another painful market crash? (After all, the market's worst time of year is approaching.) Or will the bubble come from tangible assets - like the 2006 real estate crash or the 2011 gold and silver collapse?

Let's look at some classic historical bubbles to determine what a "bubble peak" looks like.

Some Classic 20th Century "Bubbles" Give Us Some Clues

The most memorable bubbles of the last century share some general similarities - a rapid rise (say, a doubling within two years), mass participation, promises of greater riches to come, a sharp correction (say, 50% within six months), followed by several years of sideways action with no meaningful rise.

  • The New York Stock Exchange, 1927-29: The Dow was born in 1896 at 40. It took 20 years for the Dow to double to 80 in 1916. Then, it took only 10 years to double again to 160 in 1926. But starting in late 1927, the Dow doubled in less than two years to 381. In the summer of 1929, most households seemed to be dabbling in stocks, and economists spoke blithely of a "permanently high" stock plateau. But by 1932, the market retreated to its original reading of 40, and the Dow did not regain its 1929 high for 25 years, triggering fears in 1954 of another crash at those levels.
  • Gold, 1979-80: Gold was frozen at $35 for 37 years (1934-1971) until President Nixon untethered the dollar from gold in 1971. Within three years, gold soared to $200 in 1974, but that was not a bubble. Gold was simply "catching up" from its fixed price and the ban on U.S. gold ownership. Gold was not overly popular then. There were few private buyers (gold was illegal for Americans to own until late 1974), but the 1979-1980 period was definitely a bubble, since it was fueled by a mass mania. Gold more than tripled from $232 on April 17, 1979, to $850 on January 21, 1980.
  • Japanese stocks in the late 1980s: In 1950, the Nikkei index of Tokyo stocks traded at just 40% of the Dow Jones index, but by 1989, the Nikkei reached 14.6 times the Dow. (Last year, the Nikkei index fell back to 0.64 of the Dow). In the late 1980s, the Japanese ruled the financial world. The Japanese were buying American land, art and businesses. Best-selling books praised the Japanese style of management. At one point, a single square mile of real estate in Tokyo was valued above ALL the land in California. The Tokyo stock market reflected this mania, quadrupling in the late 1980s to a peak of 38,915 on the last day of the 1980s, December 31, 1989. Japanese stocks then lost 65% in 10 months and have stayed under 20,000, reflecting a chronic deflationary recession.
  • NASDAQ, 1999-2000: Talk of a "new era" dominated Wall Street in 1999. Despite fears of the coming Y2K crisis, tech stocks were doubling and tripling within months. The bubble phase began in late 1998 when the tech-dominated NASDAQ traded at 1344, doubling to 2684 within a year (September 1999), then nearly doubling again within six months, reaching a peak of 5132 on March 10, 2000. NASDAQ rose almost 40% from January 31 to March 10, 2000. NASDAQ then fell 65% within a year and has not yet approached 4000 in the 13 years since its 2000 peak.

These Historic Examples Demonstrate the Common Properties of a Bubble

We can deduce some general properties of a bubble from these examples: A rapid doubling or tripling of price, then a rapid reversion to the pre-bubble price and a long-stretch (often 20 years) of flat prices. After a typical bubble, investors are burned so badly that they vow to "never make that mistake again," but their resolution only applies to the investment that burned them. Alas, most tech stock victims soon bought into real estate with the same blinders on. Perhaps they then looked to gold or silver to rescue them in 2011.

Investment bubbles usually result from manic buying, fueled by "madness of crowds" behavior. Taken as individuals, investors are usually rational, but put them into a crowd and mob behavior often ensues. Delusions of grandeur through rapid (and effortless) wealth accumulation motivates millions of investors to pour margined money into a rapidly-rising investment to "get theirs" before the price soars further out of reach. Most of us have taken part in a bubble in our lifetime, since the lure is so great, but there is often a rational way to differentiate solid and sustainable bull markets from the spectacular surge of a bubble.

Typically, the surest sign of a bubble comes from magazine covers. Popular magazine covers tend to tell us when an investment is a "can't-miss" road to riches (when we're near the top). Magazine covers seldom warn about these bubbles in advance, since they reflect the popular bias. Then, the press calls that investment a "bubble" only after it has popped. It's a common statement that you "can't see a bubble when you're inside of it."

Bubbles Continue to Burst in the 21st Century -- What's Next?

Before looking forward, here are two recent bubbles. Not enough time has passed to verify whether or not these investments have entered their recovery phase, but so far these events "feel" like real bubbles:

  • Real estate, 2003 to 2006: The national average of all real estate prices did not double in the early 2000s, but there are plenty of anecdotal stories about manic buying and selling in desirable coastal regions, where prices doubled within a year and then doubled again - based on location, location, location. The real estate bubble was fueled by artificially low interest rates and a series of politicians of both parties who wanted to make sure that nearly every family, regardless of income or risk, owned their own home. In 2006, prices fell off their pinnacle peaks. Prices have recovered in the last year, but they are nowhere near their "bubble" peaks of around 2005-06.
  • Silver, 2010-2011: Everyone talks about the gold bubble of 2011, but silver was the real bubble story that year. From under $20 per ounce in September 2010, silver rose to $49 by the end of April 2011 - a 150% rise in under eight months. Silver nearly doubled in three months, from $26.68 on January 28, 2011 to $49.10 on April 29, before falling 30% in one week to close at $34.20 on May 6 and then falling below $20 recently. Gold never rose or fell that fast in 2011.

Many are now labeling bonds as the next bubble. Investors fear bonds will collapse if and when the Federal Reserve raises key interest rates. But the Fed has said it will NOT raise rates when it starts tapering monetary easing. The Fed has made it clear that it will keep rates low until at least mid-2015.

It's also comforting to know that stocks and bonds rarely (if ever) collapse at the same time, so a balanced portfolio should protect most investors against a sharp drop in either stocks or bonds. It's also a mistake to focus on the 10-year Treasury bond since the average maturity held by the public is barely five years.

Bear in mind that the volume of Treasury bond offerings is down due to a lower federal budget deficit this year. The Fed has also been actively selling short maturities to accumulate longer-term bonds in its attempt to flatten the yield curve. Most investors favor short-term Treasuries which are less subject to sharp drops as long as the Fed maintains its stated policy of keeping short-term interest rates ultra-low.

There is no current bond mania driving prices higher. According to the CONSENSUS Bullish Sentiment Index released this week, only 23% of investors are bullish on Treasury Bonds. The editors of that survey say that 75% marks an "overbought" market, while 25% marks an "oversold" market. No apparent bubble there.

The Latest Gloom And Doom Scare over a Potential Stock Bubble

Marc Faber, editor of The Gloom, Boom & Doom Report, says that 2013 is on the same track as 1987. His prediction was prominently featured last week on CNBC, the Drudge Report and MarketWatch. Faber expects a 20% or more market decline, similar to October 1987. He argues that corporate earnings growth has slowed to a crawl, just like in 1987, and that the averages are being held up by a few big stocks.

Faber seems to be wrong about the slowdown in earnings, both now and in 1987-88. Earnings recovered sharply in 1988, lifting the market higher. There was a record volume of stock repurchases and leveraged buyouts in 1988 due to lower stock prices. (See U.S. Corporate Leverage: Developments in 1987 and 1988, by Ben Bernanke and others.) Today, with 90% of S&P 500 companies reporting second quarter results, 66% exceeded analysts' estimates, with earnings for these 448 companies up 4.1% year-over-year.

More importantly, according to economist Ed Yardeni, earnings estimates for the S&P 500 in 2014 are still around $123, implying that "analysts collectively expect earnings to grow 11.3% next year."

Stocks are rallying based on solid fundamentals: Economic growth statistics are picking up, the Fed is still pumping out new liquidity, new technologies promise to make America energy-independent by the 2020s, the S&P 500's dividends still yields more than bank CDs, and corporate earnings continue rising.

It's amazing that analysts who predict crashes still garner the headlines, while those who compare 2013 to 1995 fail to score many major media headlines. Why do fear-mongers talk about 1987's crash while ignoring the market's quick recovery in 1988-89? Fear still trumps hope in the press.

For a classic bubble to develop, there typically must be a meteoric rise in prices, coupled with a public mania to get on board, bidding prices up. There has been no such sudden rise in this bull market. Recent market gains have seemed almost serenely gradual. The volatility index (VIX) has fallen during the entire 4½-year bull market, and the S&P 500 hasn't had a 2% up day in 11 months. That doesn't sound like a bubble, does it?

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.