Could One Stock Provide A Reliable Bubble Meter?

"During the 1980s, Japan experienced an extraordinary speculative boom that resulted in a bust that has plagued the island nation for the last 20 years," Mansharamani wrote. And on the last day of the decade, December 29, 1989, the Nikkei 225 index hit its all-time high of 38,957.

But assets such as stocks and real estate weren't the only ones to benefit from the 1980s boom. Art enjoyed its fair share as investors and speculators with bloated portfolios bid prices for such pieces as Vincent van Gogh's "Still Life: Vase with Fifteen Sunflowers," which sold at a Christie's auction for an unprecedented $39.9 million to a Japanese buyer in March 1987. It was more than three times the previous record price of $10.4 million for a painting.

FIGURE 1: DAILY CHART OF SOTHEBY'S HOLDINGS (UPPER WINDOW) AND THE NIKKEI 225 (LOWER WINDOW)
Chart courtesy of www.GenesisFT.com

BID would not peak again for almost another decade, in April 1999. But this time, it wasn't the Japanese wealthy doing the bidding; it was US millionaires and billionaires, many of whom were made wealthy thanks to the Internet bubble. As Figure 2 shows, Sotheby's stock price peaked 11 months before the Standard & Poor's 500 and NASDAQ Composite indexes (see Figure 2).

Sotheby's next stock price peak occurred on October 11, 2007, at the same time the S&P 500 was peaking. A little over three weeks later, BID had been cut nearly in half! By the time it hit its next bottom, BID had lost more than 88% compared to a 57% maximum drop for the S&P 500 over a similar period.

FIGURE 2: MONTHLY CHART FROM 1989 THROUGH 2011 SHOWING SOTHEBY'S, THE S&P 500, AND THE NIKKEI 225
Chart courtesy of www.GenesisFT.com

"Sotheby's stock price going back to 1988 when it went public has been a reasonable proxy for global animal spirits. Anytime you see bubbling art prices, it's usually a sign that we have bubbly conditions somewhere in the world," he said. "After going public, the Japanese art buyers that were setting world record prices led [Sotheby's] stock price up to a new high very quickly and then retrenched."

He stated that he believed the May 2011 drop in Sotheby's earnings and drop in stock price were a reflection of a sign that billionaire buyers were retrenching, similar to what occurred with Japanese investors the late 1980s.

From a trader's standpoint, the possibility that BID could be a bubble indicator is too tempting not to explore. In two prior stock market peaks, BID rolled over months before the market with one exception, and that was in October 2007. Sometimes it gives lots of warning and at least once, it has been a coincident indicator. But if history is any guide, a significant drop in BID over a short period should not be ignored.

We have inserted a short-period relative strength index (RSI), which has provided further confirmation of an impending market top. As we see in Figure 2, the 1999 BID peak was preceded by weakening momentum as shown by the negative divergence between the RSI and stock price (see point 1). The same thing occurred at point 2 when the RSI again demonstrated negative divergence well ahead of the stock price peak.

At point 3, observe that the RSI again began diverging negatively with BID nearly a year before the April 2011 peak.

In Figure 3, we take a closer look at the performance of BID compared to a proxy for the S&P 500, the S&P 500 SPDR exchange traded fund (ETF) (SPY).

From June 1997 to the April 1999 peak, BID jumped 160% versus a gain of less than half that amount by SPY. In 2006-07, BID soared more than 240% versus a much smaller move in SPY. From its last low in early 2009, BID took off again but then quickly dropped 25% by May 13 from its early April peak.

FIGURE 3: WEEKLY PERFORMANCE CHART OF SOTHEBY'S VERSUS THE S&P 500 SPYDER ETF SPY SHOWING PEAKS AND TROUGHS. The last peak in BID occurred on April 5, 2011, when it was up 223% from June 1997 versus a gain of 54% for SPY. By May 13, BID was off 25% from its April 5 peak.
Chart courtesy of www.VectorVest.com

Readers of his analysis who concluded that US stocks had peaked would have erred if they came to the conclusion that the bull was over. But in fact, the April 2010 BID peak did coincide with a peak - that of the Chinese Shanghai Shenzen Composite index - after which the index dropped 27%. And as of early September 2011, the Shanghai index had still not regained its April 2010 high.

What a proper interpretation of BID is trying to tell us requires an understanding of what is driving the art bubble. Only time will tell if the April 2011 BID peak was an indication of an impending top in US stocks or bubbling in another market. But based on the history of BID, it has proved to be a useful indicator of a popping bubble. The nationalities of those who have been most active in buying expensive art are prime suspects.

SUGGESTED READING

• Blackman, Matt [2011]. "Is Sotheby's A Bubble Proxy?" Traders.com Advantage, May 13.
  http://technical.traders.com/tradersonline/display.asp?art=5972
• Bloomberg News [2011]. "Art Price Trend Is Down," May 12, interview with Vikram Mansharamani.
  http://www.youtube.com/watch?v=ruMBfvCTiB0
• Mansharamani, Vikram [2011]. Boom, Bustology: Spotting Financial Bubbles Before They Bust, John Wiley & Sons.