There’s No Such Thing as a Stock-Market Bubble
Every time the market falls, the pundits come out with the same diagnosis: It was a bubble, speculators lost their minds, and somebody should have stopped them. This time the pundits are early. They decided artificial intelligence is a bubble before anything had fallen. Really? Why would rational investors suddenly lose their minds?
Start with the word itself. What is a bubble? The bubble callers mean a price that hype has pushed above fundamental value. Notice what that assumes: that there is a true price, that the market has lost sight of it, and that when prices come down, reality is correcting a delusion.
This totally misunderstands prices under uncertainty and volatility. There is no true price to lose sight of. The value of a new technology is uncertain, and a price isn’t a verdict on what it is worth. It is the market’s best guess: every possible future weighted by its likelihood of payoff, made by millions of people with their own money on the line and more information than any pundit can hold. The market isn’t “right.” It’s just a much better instrument for predicting value under uncertainty. When prices fall, that isn’t a delusion correcting. It’s uncertainty resolving.
Go back to 1999. An internet stock trades at $100 a share. If it turns out to be the next Amazon, it goes to $1,000. If it turns out to be the next Pets.com, it goes to zero. Say the market puts the chance of becoming Amazon at 15%. Do the arithmetic. Fifteen percent of $1,000 is $150, so at $100 the stock isn’t expensive. Buying it is a sensible bet.
Now it turns out to be Pets.com, and the stock goes to zero. Was it a bubble? No. The buyers were betting on a 15% shot, and the 85% came in. The best guess of the stock’s value was $150, and the most likely outcome was zero. Both were true at once, but most pundits can hold only one of those ideas in their heads. And 15% isn’t rare. A random day is a Tuesday about 14% of the time, and nobody is shocked when it’s Tuesday.
