The likelihood of a U.S. stock market crash is currently below average, according to “froth forecasts” by State Street Associates, based on Harvard professor Robin Greenwood’s research. They estimate an 18% probability of a 40% decline within two years, lower than the five-year average of 26%.
The same applies to the high-tech sector, which has seen dynamic returns. State Street pegs its crash probability at four percentage points below the five-year average.
Yale’s Will Goetzmann argues that bubble predictions reveal more about the analysts than the objective crash probabilities. Many lack rigorous criteria for defining a bubble or crash, inflating subjective predictions.
Greenwood’s and State Street’s probabilities are tied to the market’s recent performance. Higher past performance increases the crash likelihood. A 100% price run-up in two years raises the crash probability to 50%, and a 150% run-up nearly ensures it. However, the S&P 500’s 48.9% return over the past two years is well below these thresholds.
Market concentration is another argument for an imminent bubble. The cap-weighted S&P 500 has outperformed the equal-weight version by over 10 percentage points this year and by 12 percentage points last year.
This concentration in large stocks is seen by some as a sign of market vulnerability. However, historical data since 1970 shows no consistent pattern supporting this view.
Despite being overvalued, the market has multiple ways to adjust besides crashing. Based on State Street’s forecasts, a gradual correction through mediocre performance is more likely than a sudden crash.
