A couple weeks ago, SA published my Bursting Bubbles Blast Baby Boomers in which I lay out the reasons that bubbles currently exist and estimate how and when they will burst. In this article I point out that the recent soaring in stock prices argues for a big burst of at least 43%.
In case you haven’t noticed, the S&P500 index has increased 75% since the March 2020 decline. Put another way, if you invested $10,000 in an S&P 500 index fund on March 23, 2020 it would be worth $17,500 today. That growth is statistically significant at the 99th percentile – it’s really big. And it’s even more amazing that it has occurred as the economy is struggling to recover from the pandemic.We discuss this and more in this video.
Huge, but there have been bigger
The following graph shows the growth in the S&P 500 index over the past year and indicates levels of standard deviation (σ) above the mean in order to recognize the statistical significance of this return. The average 11-month return over the 96-year history of the S&P is 9.4%.
The highest 11-month return ever on the S&P is 132% earned in the 11 months ending May 1933, so the current 75% return is not without precedent but nonetheless it’s a huge outlier. The big question now is what will happen next.
As we entered 2021 it was widely believed that the US stock market was in an overvaluation bubble, and that the pandemic was the match that lit the overvaluation tinder, but that fire was extinguished big time with a 75% run-up in the market. From the current level it would take a 43% loss to bring the S&P back to its March 2020 level, which at the time was believed to be just the beginning of a deeper retrenchment. In other words, the bubble has been inflated even more, which means its bursting will be even bigger, arguably bigger than 43%.
Widening the disconnect between the stock market and the economy
And the bubble is inflating in the midst of a struggling economy. Unemployment is stuck at around 6.5% and many have left the workforce indefinitely, so they are excluded from the numbers. The economy is expected to recover in 2021, but there is still a lot of uncertainty about the repercussions of the pandemic.
The US stock market cannot defy gravity forever. If something cannot go on forever, it will end. The 75% increase in prices over the past 11 months is seductive. Fear of missing out (FOMO) is the flavor of this month so far.
Please watch our Baby Boomer Investing Show for more details.