The NASDAQ Bubble Pops!

CNBC commentator Jim Cramer finds the current NASDAQ "sell-off" dramatic and extraordinary. Cramer hasn't "...seen this sort of thing since the NASDAQ peaked in the year 2000." Since the NASDAQ index is primarily composed of tech stocks, Cramer thinks there are too many tech IPOs chasing too few dollars. What's going on?

If you're one of the investors that think the NASDAQ has been primed to take off since 2013, you probably thought the heavy red line in the graphic above would describe the growth path in 2014 and you would have been shocked by the sell-off. If you were a traditional chartist, plotting highs and lows, you might have thought the correction had to happen eventually, so you are not all that surprised. But would any of these investors have thought the NASDAQ was in a bubble as did economist Robert J. Shiller (here)? Many stock analysts were arguing that the NASDAQ was definitely not in a bubble.

The dotted green and blue lines above are the 98% bootstrap confidence intervals in the NASDAQ composite index (^IXIC) dynamic attractor path (the dashed red line). The dynamic attractor path is being driven but the US economy and the US economy has not been growing at a rate that would support NASDAQ 4000 until sometime well into 2015 (Cramer hints at this when he says that "...some actual growth in the economy...opens up the possibility of much higher earnings of traditional techs..." Of course, the opposite is also true with low growth!).

Taking a little longer perspective, as Jim Cramer tried to do when recalling the 1997-2000 dot-com bubble, it is easy to spot the stock bubbles from the NASDAQ dynamic attractor path (above). It is also easy to see how wrong analysts can be when drawing take-off lines on graphs. Also notice that the long-run forecast for the NASDAQ is not really great after 2020. Your intuition about attractor paths should tell you why: the forecast for the US economy is not that great!

Returning to Jim Cramer's observation that "too many IPOs are chasing to few dollars," IPO activity might be one signal at the beginning of a bubble and the shortage of investment funds might be another signal that the bubble is going to pop.