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Detecting a tech bubble - Arvind Narayanan's journal [entries|archive|friends|userinfo]

Detecting a tech bubble [Nov. 9th, 2009|12:28 pm]
Arvind Narayanan
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The graph below compares the NASDAQ with the Dow over the last decade and a half. The tech bubble sticks out like a sore thumb, which makes sense since the NASDAQ is technology-dominated. On the other hand, the current recession affected both indices in exactly the same way, since it wasn't tech-related.

Back in 2007, the Richter Scales made a famous video which made the point that we were in another tech bubble that was about to pop. It was scary, and at the time I didn't know whether to believe it or not. But now I wonder if the NASDAQ — DJIA spread might be a simple and reasonably reliable indicator.

I'm not very knowledgeable about finance and the economy; any thoughts?

[User Picture]From: drederick
2009-11-09 09:26 pm (UTC)
The problem is that bubbles occur because people involved think that the valuation increases reflect something real and substantial. It's not enough to point out that tech stock prices are higher than they usually are compared to overall stock prices. The believers will say "of course, that's because technology is in the process of fundamentally reshaping the economy.. nothing will be the same after this.."

Someone could have used a similar approach in the industrial revolution to show that we were in the midst of a tech "bubble". But in that case it wasn't a bubble and increases in stock values were justified.
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[User Picture]From: arvindn
2009-11-09 10:13 pm (UTC)
You're saying that if the NASDAQ climbs quickly relative to the Dow, we may or may not be in a tech bubble.

I agree.

I'm suggesting that if we are in a tech bubble, then the NASDAQ must necessarily climb quickly relative to the Dow.

Different things.
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From: fixious
2009-11-10 11:40 pm (UTC)
I don't know much about this either, but isn't the NASDAQ a lot of other things other than tech? It may have been tech-dominated at the time of the bubble, but I think it also includes a lot of bio/pharma companies now (and it could be dominated by some other sectors later). You probably want to be looking at the chart of a dedicated tech index.

I just looked up the NASDAQ computer index against NASDAQ and the Dow. It looks like it's been well above them since the beginning of 2009.
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[User Picture]From: arvindn
2009-11-10 11:50 pm (UTC)
Interesting, thanks!
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From: ext_214475
2009-11-15 10:35 am (UTC)

Yes and No

I would restate your theory as 'An increase in the NASDAQ-DOW spread is a necessary but not sufficient condition to determine whether or not we're in a technology bubble'
As a commenter above noted, there are other times in which technology-based assets have increased in value faster than those of the general economy, but those were cases where there was an actual underlying reason for the increase - i.e. when technology was indeed fundamentally reshaping the economy.
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