Is the current market action a bubble-like that occurred in 1999-2000? There isn't any clear definition of the term 'bubble' but, in general, a bubble occurs when there is sustained and aggressive buying of stocks without regard to valuation and other fundamental considerations.
Market participants like to look for historic comparisons to help guide them in their trading but circumstances are never quite the same. There are several similarities to the internet bubble, but some major differences as well. It is very unlikely that the current bubble will develop and play out in the same manner as in 1999-2000.
One of the major differences is economic conditions and liquidity. In 1999-2000 the Fed created additional liquidity due to fear that the Y2K programming glitch would cause disruption in the banking system when the calendar rolled over from 1999 to 2000. That problem never materialized and the additional liquidity in the system helped to push stocks higher in early 2000.
Unlike the current situation, the economy was good and there was a major economic transition as commerce moved to the internet. There were no ongoing efforts to continue to supply stimulus in 2000 and when the Y2K crisis failed to materialize there was no ongoing source of liquidity.
One of the big similarities to 1999-2000 is the high level of speculation by retail traders. During the internet bubble this was driven primarily by greed and the 'fear of missing out'. Those elements exist this time as well but there are structural changes such as the elimination of commissions, trading as a form of entertainment, and the ability to buy fractional shares. All of those things point to the likelihood that retail traders are more likely to stick around even when trading becomes more difficult.
When the bubble popped in 1999-2000 it led to two years of misery. The downtrend was unrelenting and the action was still quite poor in 2002 which I recall as one of the worst trading environments I had ever encountered. Unlike 1999-2000, the current market is already in one of the worst economic situations many of us have ever seen. The likelihood is that there will be some robust recovery and that will impact the market in quite a different way even if it does see some significant correction.
So how do we navigate this very extended market and protect yourself from the popping of the bubble that many bears are forecasting?
- Don't let the word 'bubble' scare you. The word 'bubble' has been thrown around for quite a while now and that has caused many folks to move to the sidelines out of fear that they are going to wake up to a market crash. Fear of the overnight crash is not only very costly but the chances of it occurring are very unlikely. Market corrections usually don't accelerate until there is a period of indecision and uncertainty. There will be warning signs and there be plenty of opportunities to reposition.
- Late-stage market action can be extremely profitable. Big gains often occur when others are becoming fearful. Building a cushion of profits is your best defense against future losses. Don't forego great opportunities simply because there is a likelihood you will suffer some losses at a later point. Pad that bottom line and anticipate that you will give some back in the future.
- Let your individual stock positions determine your market timing. The best market timing device to use is your own portfolio. If you are losing money that is your signal to sell. If the stocks you are holding are acting poorly then dump them and raise cash. You don't need to study macro-economics and fundamental valuations. Focus on price action and let that be your guide to your market exposure.
- Embrace the power of selling. The most powerful tool that you possess is the 'sell' button. Selling is the best insurance you can buy but many people don't understand that it can be undone in the blink of an eye. If you sell a stock and then have to rebuy it higher, all you have done is paid an insurance premium.
- Ignore the predictions. No one knows how this market is going to play out and if you try to anticipate what will happen, you are likely to make some major mistakes. Rather than predict focus on quick reactions.
- Counter-trend moves provide big opportunity. Even when the market does roll over it is unlikely to go straight down. Some of the best trading in the market is counter-trend moves as they tend to be very big and very sudden. Catching these bounces is not easy but it can make for great trading when conditions shift.
Whether the current market is in a bubble or not can be debated but what is a certainty is that this is an environment that favors the small individual trader that moves fast and stays reactive. Don't forego the great opportunities because others are dismissing it as a bubble.