Parallels to the top of the internet bubble are too obvious to ignore.
The recent drop in Nvidia Corp. stock price is probably the start of something much worse for the company and other semiconductor stocks.
That’s what new research about market bubbles and how they eventually pop means. The study says it’s “nearly certain” that the market value of Nvidia NVDA, +6.76% and the semiconductor industry as a whole will drop by 40% at some point in the next two years.
The research that led to this prediction was done by Robin Greenwood, Andrei Shleifer, and Yang You at the University of Hong Kong. The Journal of Financial Economics published their study, which was called “Bubbles For Fama.” They discovered that an industry is more likely to crash if it has done worse than the S&P 500 SPX over the last two years. A 40% drop over the next two years is what the researchers call a crash.
The researchers found that there is a 53% chance of a crash when an industry’s trailing two-year alpha is 100 percentage points. Alpha is the margin by which it beats the market. Once the alpha is 125 points, it goes up to 76%, and when it’s 150 points, it goes up to 80%. After that, there is “nearly certain” to be a crash.
The semiconductor industry has had a trailing alpha of just under 200 percentage points over the last two years. The one from Nvidia is more than 600 percentage points.
2.0 dot-com bubble
There are a lot of similarities between this and the burst of the internet bubble. In the late 1990s, some dot-com stocks did much better than the S&P 500 and then crashed. There is another, less obvious connection to the peak of that bubble in March 2000, though: investors saw the first drop after that peak as a chance to buy. According to contrarian analysis, that is a sign of a major top.
Take a look at the average amount of equity exposure that Nasdaq-focused short-term stock market timers suggested in March 2000. It is this average that the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI, shows. The Nasdaq Composite’s initial 10% drop from its bull-market high did not cause the HNNSI to fall; instead, it increased by more than 30 percentage points. For investors, that meant they were feeling very optimistic. Everyone knows what came next.
It’s possible that investors will react in a similar way to Nvidia’s recent correction, which saw the company’s stock drop 16.1% in just two trading sessions. It’s impossible to know how many investors see this correction as a chance to buy, but it’s clear from reading investment blogs that a lot of them are.
Record of
This is the second time I’ve used the Harvard study to predict a crash, and it’s important to look back at how those first predictions turned out. Here is a report on those whose two-year prediction period has now passed. There are three more columns where the results are still not clear. As you can see, four of the five predictions that were made more than two years ago came true:
- Nov. 27, 2017: I reported that the odds of bitcoin BTCUSD, -0.35% crashing were greater than 80%. The cryptocurrency was 60% lower just over a year later.
- Jun. 27, 2019: In this column I reported that bitcoin was “very likely to crash soon.” It was more than 50% lower in nine months’ time.
- Feb. 4, 2020: In this column I reported that Tesla Inc. TSLA, +2.61% was forming a bubble that was about to pop. In less than two months the stock was 60% lower.
- Feb. 15, 2021: In this column I reported that the “S&P 500 Technology Hardware, Storage & Peripherals index” was forming a “bubble at risk of bursting.” This prediction was not successful, as over the subsequent two years the index fell no lower than 13.1% below the index’s level when that column was published.
- Feb. 26, 2021: In this column I reported the significant probability that bitcoin would crash at some over the subsequent two years. In 18 months’ time it was 68% lower.
