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You shouldn’t believe all this talk about a stock-market bubble about to burst — here’s why

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I say this not because I don’t think that equities are overvalued. I do, as I outlined last week. But according to the only statistical model I know of that is able to forecast crash probabilities, the odds of a bubble bursting in coming months is low.

That hasn’t stopped numerous commentators from insisting the market is in a bubble that’s about to pop. In fact, according to Google Trends, web searches for “stock market bubble” recently hit the highest level at least since 2004, which is how far back historical data extend. Jeremy Grantham, co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo (GMO), recently went so far as to forecast that the market is in a bubble that will burst in a matter of months, not weeks.

The statistical model I am referring to was the outgrowth of a study that appeared in the Journal of Financial Economics. Its authors were Robin Greenwood, a finance and banking professor at Harvard Business School and chair of its Behavioral Finance and Financial Stability project; Andrei Shleifer, a Harvard economics professor; and Yang You, a Ph.D. candidate in economics at that institution.

The researchers focused on industries and sectors, defining the bursting of a bubble to be a loss of at least 40% over a two-year period. They found that the odds of this happening were 50% whenever the industry over the prior two years had beaten the overall market by 100 percentage points. As you can see from this chart, these odds rose to 80% whenever the market-beating return was as high as 150 percentage points. And when the two-year market-adjusted return was much higher than that a crash became “nearly certain.”

By the standards of this model, no industry grouping in the U.S. market currently comes close. Of the 11 primary industry sectors in the S&P 500 index
SPX,
+1.23%
,
for example, the best performing over the last two years has been the Technology Select Sector SPDR ETF
XLK,
+0.25%
.
But it’s beaten the S&P 500 by “just” 41 percentage points, according to FactSet. Per the researchers’ model, this performance is not associated with a significantly elevated probability of a crash.

This isn’t to say that the technology sector couldn’t crash. But if you think it will, you will have to base your forecast on something other than its recent performance.

What about individual stocks? The researchers didn’t focus on them. But I nevertheless subjected each of the FANMAG stocks to their model, since those stocks are often Exhibit A in any argument about a top-heavy market that is vulnerable to a crash. These stocks, of course, are Facebook
FB,
-0.66%
,
Apple
AAPL,
-0.08%
,
Netflix
NFLX,
+1.76%
,
Microsoft
MSFT,
-0.06%
,
Amazon
AMZN,
-1.04%

 and Google parent Alphabet
GOOG,
+0.31%

 
GOOGL,
+0.50%
.
They currently represent 20.7% of the S&P’s market capitalization, according to FactSet.

Among these six, the best two-year performer is Apple, and it beat the market over the last two years by 80 percentage points. Though that two-year return is associated with a slightly elevated probability of a crash, the researchers calculate those odds to be modest. Analyzing all industries since 1926 that beat the market by this amount over a two-year period, they found that on average they still went on to beat the market by 3% over the subsequent 12 months.

What about Tesla
TSLA,
+3.21%

? It most definitely satisfies the researchers’ criteria, as its margin of outperformance relative to the S&P 500 is an eye-popping 461 percentage points over the last two years. That suggests with “near certainty that there will be a time in the next two years in which it will drop by at least 40%.

For the record, I should acknowledge that I have made similar predictions about Tesla over the last year, based on the researchers’ model. The first, in early February, turned out to come true in just six weeks: It fell 60% from its February high to its March low.

My second crash column about Tesla has not come to pass, at least yet. That column was published in early July, and the stock is 34% higher today than then. But note that the jury is still very much out on that July prediction, since it had a two-year time frame.

Why the eagerness to declare that a bubble is forming?

One other relevant finding is that bursting bubbles are rare. Between 1926 and 2012 just 40 industries beat the market by 100 percentage points over any two-year period. And of those 40, just 21 actually burst. So there is a bubble set up every 26 months, on average, and a bubble actually bursts every 49 months, on average.

What about the pandemic-induced bear market this past February and March? Did any of the industries’ losses then count as a bubble bursting?

No, at least not according to the researchers’ criteria: The best-performing of any of the major S&P 500 industry sectors over the two years prior to the February market high was, yet again, the Technology Select Sector SPDR ETF. It beat the S&P 500 over that two-year period by 29 percentage points.

Clearly, bubble predictions are far more prevalent than actual bubbles.

Why this eagerness to detect bubbles? Will Goetzmann, a finance professor at Yale University, tells me he suspects it has to do with the moral overtone that analysts associate with a bubble. When they claim we’re in a bubble, they’re going beyond forecasting an imminent bear market and implying that those who lose big will be getting what they deserve.

I suspect the temptation to apply this moral overtone will be particularly strong for those who’ve been bearish for several years now and thereby missed out on impressive stock-market gains. Grantham falls into this bearish category, and I can sympathize. Most of the long-term valuation indicators have been bearish for several years now.

Still, none of this research and data guarantees the market won’t crash. But as with any aspect of stock market forecasting, it’s important to precisely define what we mean by a bubble that bursts and then subject that definition to historical scrutiny. And the current market does not satisfy the reasonable definition employed by the Harvard researchers.

The bottom line? There probably are more pressing issues to worry about right now than whether this latest round of bubble predictions will get it right this time.

Now read:The next bear market will be the worst in at least 78 years, warns co-founder of Soros’s legendary Quantum Fund

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.



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My boyfriend inherited a home and $700K. He pays me $500 monthly rent. Should I ask him for $86K to pay off my condo?

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Dear Quentin,

I have lived with my boyfriend in my home for over 20 years. We never married, and I have three siblings. I also own another condo in the Caribbean, which I paid for myself.

My boyfriend inherited a home from his dad in the South and a large sum of money, just over $700,000. We just got back from this inherited home. He is still deciding if he/we should keep it.

I owe $86,000 on my current home, and my boyfriend pays me $500 a month rent and he pays the electric and cable bill. We also mutually share groceries. I appreciate all his financial help.


‘His ex-wife will get half of his pension and Social Security in Connecticut. I will not receive that as we were never married.’

I am 65 and get a monthly pension of $800 and receive $1,800 Social Security every month.Together, we own three condos. I have no savings, and own two properties.

He is divorced with six adult grown children. I have only met two of his children out of the six. For some reason, he does not want to get involved with their cookouts and parties etc.

He is close with his children, and speaks to his ex-wife on the holidays as needed about any of the children and grandchildren. We always travel alone. His children never travel with us.

His ex-wife will get half of his pension and Social Security in Connecticut. I will not receive that as we were never married. What should I do financially to secure my future?

Should I ask him to pay off my condo balance of $86,000, and promise to leave the condo to him rather than my siblings in my will?

He does not want to get married, for some reason; he was married once and he said he does not want to do it again.

The Girlfriend

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Dear Girlfriend,

Your offer assumes that you will predecease your boyfriend, and that is not a given. If you do not die before he does, he is essentially giving you $86,000 because (a) partners should help each other out, (b) he has newfound wealth and he should spread it around, and/or (c) it’s not fair that he should have all of this dough landing in his bank account when you have had to scrimp and save all of these years. It has a faint ring of that school-days refrain, “If you give me one of your sweets, I’ll be your best friend.” In this case, you already are his best friend. So there’s no upside there.

You have been together for 20 years and you never married. The reason for that may be at least partly related to your respective financial affairs. Your boyfriend has a lot of financial responsibilities, one home (at least he had one home before his latest windfall), children, and an ex-wife, while you have two homes, and are free of your partner’s other financial burdens. He also pays you $500 rent every month, which was obviously a convenient arrangement for both of you. But it seems late in the day to draw a line connecting his financial future, that of his ex-wife’s and your own.

Sometimes, it’s good to ask for help. People often want to help, and it’s a privilege to help out a loved one. But to ask him for a chunk of his inheritance to pay off your home, especially when you have another condo in the Caribbean that you could sell, seems bad timing at best, and opportunistic at worst, which brings us back to the “I’ll be your best friend” sentiment. You are effectively asking your boyfriend for something with nothing in return. By not marrying, you have kept your finances separate. You have gotten this far on your own. There is a lot to be said for that.

The Moneyist:I have crypto FOMO! ‘I’m too old to sit and hope I can make up for the lost time by safely investing my little bit of money’

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My ex-wife passed away. I’m the beneficiary on her life insurance. Her family wants me to pay her funeral expenses and won’t leave me alone

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I am 32, and just a month ago I found out that my ex-wife, whom I haven’t spoken to since we divorced, passed away tragically in a moped accident. My ex-wife had life insurance through her job. My ex-mother-in-law informed my father that my ex-wife had kept me as her beneficiary on her life-insurance policy, and her family wants the money for funeral costs, bills, etc.

Not only did my ex-wife have me on her policy as the primary (and only) beneficiary, she updated my home address on the policy after we divorced. Also, I found out through the insurance company that my ex-wife had two term life-insurance policies, one for me and one for my ex-sister-in-law.

I blocked my ex-in-laws, and now I received a threatening voicemail from a blocked number, so I’ve taken it upon myself to notify the authorities. I live in New York, I am remarried, and my divorce was very simple and easy. We left the marriage with what we came into it with. The life-insurance company approved the check in my name, and is sending it to my home.

Am I legally in the clear? I have not spoken to or bothered these people once since we divorced five years ago. I just want to be left alone and move on with my life.

Thank you very much in advance.

Best regards,

Fed-Up Ex-Husband

You can email The Moneyist with any financial and ethical questions related to coronavirus at qfottrell@marketwatch.com, and follow Quentin Fottrell on Twitter.

Dear Fed Up,

First, I’ll deal with your life insurance concerns, and then the subject of your ex-wife’s funeral expenses.

The life-insurance policy was between your ex-wife and her insurer. It’s possible to overturn a life-insurance policy if it explicitly goes against the terms of a divorce decree, as happened in this case, but that too was a complicated lawsuit. Some states do have statutes that can revoke such beneficiary arrangements.

In “Kaye Melin and Metropolitan Life Insurance,” the children of the deceased were awarded the proceeds from the life-insurance policy, not the ex-wife who was named as beneficiary on the agreement. In that case, the law presumed that what her ex-husband wanted after their divorce was incorrect.

The ruling stated: “Thus, if a person designates a spouse as a life insurance beneficiary and later gets divorced, Minnesota law provides that the beneficiary designation is automatically revoked. At least twenty-eight other states have enacted similar revocation-upon-divorce statutes.”


‘I’m reluctant to say that you are ‘in the clear,’ given previous court rulings, and statutes in some states on the revocation of named beneficiaries post-divorce.’

I’m reluctant to say that you are “in the clear,” given previous court rulings, and statutes in some states on the revocation of named beneficiaries post-divorce. In your case, it seems clearer that your ex-wife wanted you to be the beneficiary. She did, as you say, update your address. It would be hard to see a more explicit sign of her intentions than that.

“Unless the policyholder of the life-insurance plan changes the beneficiary designation officially, the people originally named will remain the beneficiaries through the life of the policy,” according to Heban, Murphree and Lewandowski, a law firm in Toledo, Ohio. “Even if the policyholder was not on speaking terms with the individual upon his or her death, that beneficiary would still receive the income.”

“In the case of someone who divorced and remarried, the policy may name the first spouse as beneficiary. If the policyholder never changed the policy to reflect the divorce and remarriage, the ex-spouse could end up with the benefit. This can cause the current spouse and any children from the second marriage to dispute the beneficiary designation on the policy,” it adds.

But much, I suspect, would depend on what state you live in, and the specifics of your case.

On a separate issue, it’s difficult to glean from your letter whether your in-laws had little funds to pay for the funeral expenses, or were mad as hell that you were listed as beneficiary and felt you should contribute, or both. On the one hand, it seems like they are not in a state of mind to be reasonable and, chances are, if you did engage it would lead to further demands and acrimony.

Perhaps you could talk to your ex-wife’s lawyer and see if there is enough money to cover the costs of her funeral and, if not, you could make a contribution. But given the alleged harassing phone calls, their anger and grief, and their antipathy toward you, you would need to have all correspondence go through the attorney and refrain from any direct communication.

There is no excuse for their taking their grief out on you. Still, spare a thought for her family. If you are fed up, imagine how they feel.

The Moneyist: My boyfriend talked me into depositing my paychecks into his bank account, and paying for a car in his name. What can I do?

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These money and investing tips can help you when inflation is burning a hole in your wallet

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Don’t miss these top money and investing features:

These money and investing stories, popular with MarketWatch readers over the past week, focus on helping you make sense of the recent spike in U.S. inflation. Understand how rising prices can affect your investment portfolio, and taking appropriate steps now to respond, can prevent unpleasant surprises later.



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