The word “bubble” gets thrown around left and right these days.

If an index, stock, or cryptocurrency rises too fast for someone’s comfort level, often they’ll just call it a bubble… regardless of the facts and usually based on emotions.

Most of the time, this reaction is due to an emotional mix of anger and resentment for missing a rally.

But what I’ve noticed is that the pockets of the market that meet the bubble criteria, do get punished… and pretty quickly.

Things like Robinhood (HOOD) and Virgin Galactic (SPCE) got rightfully hammered, while the market as a whole continued to rise.

These were two “hype profit” recommendations we made recently. Both hit our downside targets. In the case of SPCE, we published the essay after the stock already came down 10% on July 15 and still felt confident enough to call for an additional 40% decline.

Looks rational to me…

The fact that blatant hype gets punished in this market should point to the fact that maybe we’re not in an overarching bubble, even though some areas of the market are clearly there.

So, what actually is a bubble?

One of the best definitions I’ve seen comes from Richard Bernstein, founder of RBA advisors… and a pioneer of market segmentation indicators for all you data nerds (like myself) out there…

He stated:

When I used to teach at the NYU/Stern Graduate Business School, we’d cover what determines a financial bubble. Based on my readings of financial history, I came up with five characteristics of a financial bubble. Portions of the current market are exhibiting all 5 characteristics.

The five characteristics are:

  1. Increased liquidity.
  2. Increased use of leverage.
  3. Democratization of the market.
  4. Increased new issues.
  5. Increased turnover

I remember sitting in that class, amazed at this neat little checklist. Looking back, it’s probably why I’m always skeptical when others get overly excited…

In the excerpt above I emphasized “portions” because it’s a nuance most bears miss.

Painting the market with broad negative strokes is just a bad approach. Consistently missing out on great opportunities is just as bad losing money on hyped investments like HOOD and SPCE. Both are due to a major flaw in “judgement” and a complete misunderstanding of what moves markets.

The best rendition describing this type of “permabear” mentality I’ve heard comes from our friends over at Casey Research:

If the market is sky-high, it’s a bubble – stocks must fall.

If the market is high but not sky-high, it’s overvalued – stocks must fall.

If the market is on the way up after a crash, it’s a rebound in a secular bear market (don’t ask!), and it couldn’t possibly last – stocks must fall.

And if the market has just crashed, well, it’s just the beginning of a bigger crash – stocks must fall.

In the perma-bear’s mind, stocks are never ever cheap enough.

I must admit, the essay got me thinking, “am I one of these bearish creatures?”

After all, the skeptical mind can easily fall victim to the permabear mentality. I say all this because as the market is taking a “breathtaking” step back from highs, many are calling for a crash…

“Valuations are too damn high!” cry the bears.

For the most part, that’s true relative to historic standards…

But then that logic should force them to buy value… where valuations in the energy sector run for about 12-15 times next year’s earnings. Reasonable, especially when looking at historical averages. 

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Now that it’s September, many are citing seasonality, since it brings drawdowns.

So, as we find ourselves in the “throes” of a 1.5% drawdown, it’s easy to blame it on the September effect.

But, here’s another effect to take a look at – another form of “seasonality.”

It’s the seasonality related to the monthly options expiry schedule…

Take a look at the chart below, and you’ll see what I mean…

(Click here to expand image)

Every market drawdown this year has come around option expiry (the circles)… and after that expiry, the dip buyers have stepped in.

The next coming option expiration occurs on September 17. Any market move in either direction for the next couple of days should be taken with a big grain of salt, since the dust needs to settle from this options expiry.

Although all traders love a good market correction, it’s too early to go all in on the short side.

However, if this coming option expiry cannot find the dip buyers, the S&P 500 will not bounce so gingerly off the 50-day moving average (MA) for the eighth time this year, as we described in last week’s essay.

And if that’s the case, then those longer-term moving averages – like the 100-day and 200-day – will most likely at least get tagged.

So, what’s a fair downside target?

Let’s say it falls 10%. At most, the market would tag the 200-day MA line and we’d still be in a long-term uptrend.

Without a policy mistake or black swan event… I will be viewing that development as a tremendous buying opportunity.


Eric Shamilov
Contributing Editor, Market Minute

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