When will the bubble start on Wall Street?

Sometimes in finance we talk about the bubble, understood as a particularly speculative dynamic of an upward trend.

But how do you identify a bubble on stock markets and what is the purpose of identifying it? When will the bubble start on Wall Street?

All too often, in trying to identify a bubble, subjective elements are used, such as particularly bullish movements or too high price levels.

But then, when one wonders when a movement is excessively bullish, or has reached an excessively high price level, the uncertainty of valuations often reigns, once again subjective.

Moreover, even the duration of a bubble is not determined a priori, so in the absence of further elements of analysis, identifying it would even become superfluous.

But things change not a little if we replace an objective conception with a subjective and discretionary conception.

In this way we will be able to understand when prices may have reached the final phase of a bullish trend. Moreover we will be able to understand also when the bubble deflates and the inversion of the trend arrives, regardless of the projections that have been formulated.

The statistical criteria

To give a definition of an objective bubble, we must consider that usually, in a trend, prices remain confined to some minimum and maximum levels, defined statistical confidence levels.

We can represent these levels with the traditional bullish channels, including between a dynamic support and its resistance parallel.

When the courses come out upward from this channel, a statistical excess is generated, which we can consider as a bubble.

Identification of a bubble with fundamental analysis

But the concept of a bubble can also be applied in terms of fundamental analysis.

Estimated the fair value of an asset, we can assess whether the same is a premium or a discount.

In many cases, premium quotations of 30 per cent are higher than fair value.

Higher prices could be considered a form of bubble based on fundamental analysis.

When will the bubble start on Wall Street?

Are the US Stock Indices up for grabs?

We therefore try to apply these concepts to US stock indices.

In yellow the bullish index channel, on monthly bar charts, while the horizontal red line indicates the price level equal to the fair value, calculated with the modified Fed method, increased by 30 percent.

In red circles the bubble situations.

S&P 500

Dow Jones industrial

Nasdaq 100

We note that for some time now the three stock indices have been on the bubble both from the point of view of the exit from the channel, even if the S&P 500 in a decidedly lower measure, and from the point of view of exceeding its fair value level, increased by 30 per one hundred.

As we have said on another occasion, the projections indicate the courses directed towards a potential top of long around August 2020, but obviously it is not excluded that the bubble can burst, as it is said in jargon, before or after.

For this reason it is preferable to follow the possible violation of some long media and only in this case we can say that we have a reliable statistical end-of-bubble signal.

In fact, especially in periods of limited or negative bond yields, the formation of bubbles is more frequent, and their duration can also extend over a prolonged period.

To catch possible bursts of the bubbles, but also a possible reversal of the long trend, a first alert would intervene, on the US indices, based on the PLT method, in the event of a December closure, respectively lower than the following levels:

S&P 500 2,822

Dow Jones 25339

Nasdaq 100 7,356.

Curated by Gian Piero Turletti, author of "Magic Box" and "PLT"