Tuesday, September 17, 2013

Three Bubble Lines

I can see clearly now the rain is gone
I can see all obstacles in my way
Gone are the dark clouds that made me blind
--Jimmy Cliff

Every now and then it helps to grab a 'big picture' view for perspective. The below chart shows monthly S&P 500 (SPX) prices since 1980. Let's note a few things.

First is that the smooth uptrend pattern that characterizes the first half of the series (let's call this the Normal Progress Line) looks nothing like the saw toothed, zig zaggy pattern that characterizes the second half of the chart.

The saw toothed pattern began in the mid 1990's when it lifted off from the Normal Progress Line and went nearly vertical. Let's call that steep sloped line a Bubble Line. Three Bubble Lines are present in the saw toothed phase of the series.

The first Bubble Line corresponds to what is often referred to as the 'dot.com bubble.' It gets this label because the marquee event during this period was the astronomical appreciation of Internet-related stocks. That bubble popped in 2000 and deflated until early 2003.

The second Bubble Line then began tracing its path higher. We commonly label this period the 'housing bubble' because the marquee event during this period was the astronomical appreciation of real estate and associated real-estate securities. That bubble popped in 2007 and deflated until early 2009.

Interestingly enough, the 2009 low corresponds to position of the Normal Progress Line if its slope is extrapolated forward.

Since early 2009 a third Bubble Line, corresponding to the 'QE bubble,' has been tracing a path higher. It can be called the QE bubble because it has been characterized by unprecedented money printing and securities buying that has fancily been labeled 'quantitative easing' by central bank sophisticates. Unlike the previous two bubbles, there is no particular asset class that has benefited from this round of easy money policy. Instead, all financial asset classes have been floating higher on an ocean of central bank induced liquidity.

This third and final bubble has yet to deflate. When it does, note how far down stock prices have to fall to reach the Normal Progress Line. The SPX would have to fall by 50% from here.

Given long term tendencies of markets to overshoot in both directions, and that actual prices have been above the Normal Progress Line for going on 20 years, it is easy to conjecture that popping the QE bubble will drive prices below the Normal Progress Line for an extended period of time.

position in SPX

1 comment:

dgeorge12358 said...

Warren Buffett points out that the Dow Jones Industrial Average rose "a staggering" 17,320% in the 20th century. Here's the problem: During nearly the same period, Buffett says GDP per capita rose much less about 500%.
~Stephen Gandel, Fortune, 3/1/13