In March of last year, we wrote an article entitled “Timing the End of the Tech and Bitcoin Bubbles”. Our conclusion for Bitcoin was that it was indeed in a bubble but that there was insufficient technical evidence at the time indicating its bursting. We explained: “until Bitcoin shows credible signs of a topping out process as detailed in prior bubble bursting examples, calling a reversal could prove premature and perhaps hazardous to your financial health.” Now there is, marking November 2021 as the peak! More on that later in the article.
Our conclusion did not specifically target the technology sector per se, but more its performance relative to energy, a relationship that had swung to a multi-decade extreme. At the time we observed: “that long-term leadership is in the process of reverting away from technology and moving in the direction of energy and other resources.” In this instance we used the tech dominated NASDAQ as a proxy due to its longer historical record, and the S&P Integrated Oil Index as that for energy and resources. Both industries faced potential regulation. In technologies case, greater government interference was expected to act as a headwind for profits, whereas increased energy regulation would hamper supply and enhance profits through higher prices. Chart 1 shows that the ratio has fallen sharply in the intervening year to the extent that some sort of oversold bounce is likely as part of an overall multi-year decline favoring energy.
Chart 1 NASDAQ/Energy Ratio and an 18-month ROC 1995-2022
The 12-year uptrend in this relationship has reversed to favor energy over technology. Source StockCharts.com
Before we take a closer look, a few observations on bubbles are in order.
What is a Bubble
A bubble develops when the price of an asset has been rising for many years. It culminates in an almost exponential rise that abruptly reverses, as prices move to levels that cannot be sustained by the underlying fundamentals. An easy money policy helps the bubble inflate, a tighter one normally causes its demise.
Measuring Bubble Type Conditions
There are of course, many aspects that characterize bubbles and manias, several of which you can read about here. Sentiment plays a huge part, but apart from gut feel, which is not statistically accurate, it is extremely difficult to pin-point the beginning of the unravelling process. That is because there are no long-term indicators that can be consistently applied across multiple markets. Furthermore, when sentiment data is available, it takes the form of short-term polling, rather than information gathered with the purpose of assessing a long-term perspective. A key problem is distinguishing a perfectly normal experience, such as a stock or commodity doubling over a five-year period and something that is far more insidious. A good example would be when the S&P grew by a factor of 2.5 in the 10 years separating its 1974 low and 1984 high. Prices seemed a bit heady at the time, but it was no bubble.