It's pretty easy to see we have a bubble in select Nasdaq (NASDAQ:QQQ) stocks. I've talked about it in a previous article, showing how it's not hard to find more than a dozen stocks trading at price/earnings in the hundreds. Indeed, many of the stocks I highlighted aren't even producing profits now in spite of their multi-billion market capitalizations.
It's also easy to understand that the debt ceiling debate, and the government shutdown, can be construed as negative for the markets. And indeed, both last year and now this debate has led to increased market volatility.
But there's another angle, which is also interesting when we marry these two realities: the existence of a bubble, and the bearishness of the debt ceiling debate and resulting government shutdown.
The other angle is brought to us through the research of Dilip Abreu and Markus K. Brunnermeier, put forth in their January 2003 paper "Bubbles And Crashes."
In this paper, Abreu and Brunnermeier argue that bubbles can exist even in a market where there are well-informed and well-financed arbitrageurs. That is, even in a market where there are actors able to see the bubble and sell into it massively enough to destroy it. Today's market would be one such market, where the bubbles are easy to see and there are more than enough hedge funds and institutions able to sell into those bubbles and destroy them.
Yet, the bubble lives on. Why does it? Abreu and Brunnermeier show that it's possible for this to happen because although the well-informed arbitrageurs are more than powerful enough to destroy the bubble when acting in aggregate, for that to happen the aggregate of them would have to act at the same time.
And therein lies the relevance of the debt ceiling drama. It can, much like an earnings report or some other significant event, act as the catalyst that coordinates the well-informed, well-financed actors to act simultaneously to sell the bubbles.
It is in this regard that as long as the debt ceiling drama lasts, many of the bubbles I identified including Amazon.com (NASDAQ:AMZN), LinkedIn (LNKD), Salesforce.com (NYSE:CRM) and others are at a significant risk of popping. This is so in spite of fundamentally, the debt ceiling debate really not being all that important for the valuation of these equities.
As research shows, it's possible for bubbles to appear even in a market with enough well-informed, well-financed actors able to destroy them. However, it's also possible that any kind of event might serve as the catalyst which drives those same actors to coordinately act against the bubbles, thus popping them even though no new fundamental information is brought to the table which justifies popping the bubble at this time. The debt ceiling debate can be one such event for the tech bubbles of today.
Disclosure: I am short AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.