Over the past few months stock markets have been registering very positive performance. Some analysts claim the markets are in a bubble condition. Bubbles can emerge from cognitive biases, herd behaviour and involve positive feedback loops which accelerate bubble growth. The S&P, for example, has tripled since its low in 2009. Since the 1990s, the economy and stock markets have experienced the dot-com bubble, the mid-2000s housing bubble and now, it appears, we’re approaching the third big bubble: the stock market bubble. Now, bubbles do not necessarily have to burst. However, if they do, they involve a massive decline in stock prices in a very short period of time, typically a few days.
Whether markets are in a state of bubble, or if and when it will burst, is not something that can be determined on rigorous scientific basis. However, a bursting bubble will certainly cause more damage if the domain it embraces is fragile. In a fragile environment the effects of destabilizing events or shocks are generally more severe and can spread very quickly. The exit of Greece from the Euro is an example of a potentially destabilizing event.
A measure of how well a system is able to withstand or absorb destabilizing events or shocks is resilience. Resilience is measured on a scale ranging from 0% to 100%. High values of resilience, say above 80%, reflect systems that are relatively well equipped to face shocks and/or sustained turbulence. Values below 50% point to systems which fragile. However, high fragility is not guarantee of failure – it merely points to system which will have a traumatic collapse if and only if a sufficiently severe shock hits them.
We have measured the resilience of major stock markets and market sectors over the past few months. The results are illustrated in the plots below, where a red arrow indicates the current tendency. First we examine some major stock market indices.
The analysis reveals that most of the major stock markets are on a downward trend in terms of resilience. This is certainly not good news. The fact that many of these markets already have low values of resilience (S&P, CAC 40, FTSE) is also not a good omen. The Asian markets (STI and HSI) are significantly more resilient and show a stable or upward trend. In terms of specific market sectors, Oil & Gas is very fragile (steady at 40%) as well as Automotive (55% and dropping) and Telcos (45% and dropping). The opposite situation is that of the system of large US and EU banks, with a resilience of 75% and growing. As for the Global Financial Resilience Index, which takes into account 40 of the World’s major stock markets, reflecting the stability entire global financial system, it is close to 60% but a diminishing trend is clearly visible. The alarming threshold of 50% could be reached in 3 to 4 months (around September 2015) if the current trend continues.