A few prominent researchers have been blowing big bubbles lately about how their valuation models can predict future stock prices. Well, their bubble is about to be popped. The future return of the market can be predicted with a newly discovered model — based on the price of bubblegum.

Chewing gum has been around since ancient Greece. It was made from the resin of mastic trees. The very first bubblegum was invented by Frank Henry Fleer in 1906. He called it Blibber-Blubber. Today, dozens of companies worldwide produce and sell bubblegum under an assortment of brand names.

I thought it would be interesting to compare year-end S&P 500 prices to year-end bubblegum prices to see if the cost of one piece had any predictive value. I constructed the price-to-bubblegum ratio (P/BG) that compared the past prices of gum relative to an earning-adjusted S&P 500 price. To my surprise, bubblegum does a good job forecasting the market.

I created a bubblegum price index from 1953 to 2012 using prices found on old bubblegum wrapper images posted on the internet by collectors. Years where there were no prices available were interpolated using the Consumer Price Index (CPI). I then multiplied the gum price by factor to increase the size of the denominator in the P/BG ratio.

Robert Shiller’s online database (see hyperlinked Excel file) was used to construct an earnings-adjusted S&P 500 closing price from 1953 to 2012. I wanted to measure the price of the S&P 500 as if annual real earnings growth was factored out of the return data each year. This allows the S&P 500 price at the end of one year to be compared to other years without the difference in real earnings levels getting in the way.

The adjusted S&P 500 closing levels were then compared to bubblegum prices over the 60-year period. Figure 1 illustrates the change in the P/BG ratio from 1953 to 2012.

**Figure 1: Earnings-Adjusted S&P 500 Price-to-Bubblegum Ratio (P/BG) 1953-2012**

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*Sources: Robert Shiller online database, historic bubblegum prices found on the Internet*

The P/BG ratio low was about 20 while the high was 150. The central P/BG tendency was between 35 and 44. The Pop Zone and Flavor Zone levels will be explained soon.

My intent in the study was to measure the P/BG ratio predictive value. Each year from 1953 to 2003, I measured the 10-year forward price return for the S&P 500. There were 60 independent periods. Figure 2 compares these results to each starting P/BG ratio. The horizontal axis (X-axis) is the P/BG starting ratio each year and the vertical axis (Y-axis) is the annualized 10-year forward return from that year.

**Figure 2: Starting P/BG Ratio and Future 10-year Earning-Adjusted S&P 500 Returns**

*Sources: Robert Shiller online database, historic bubblegum prices found on the Internet*

There appears to be a strong relationship between starting bubblegum prices and the future return of the S&P 500. When the starting P/BG ratio was low, the future 10-year stock market return was high and when the starting P/BG ratio was high the future return was low.

Figure 3 vividly documents this relationship. The P/BG ratio was divided into three groups based on the level; Below 30, 30 to 50, and Over 50. The average annualized future 10-year return for each ratio group is illustrated.

**Figure 3: Starting P/BG Ratios and 10-Year Annualized S&P 500 Forward Price Return**

*Sources: Robert Shiller online database, historic bubblegum prices found on the Internet, image from Flickr*

The Bubblegum Ratio looks to have significant predictive value for future stock returns. Market returns were highest when the starting P/BG ratio was below 30 and lowest when it was over 50. Starting ratios between 30 and 50 also returned a respectable 10 percent annualized on average.

Refined data analysis finds that a P/BG ratio over 44 puts the stock market in the “Pop Zone” and in danger of low returns. A ratio below 28 was in the “Flavor Zone” and delivered annualized returns over 13% in every case. Investors could develop a profitable trading strategy using the Pop Zone and Flavor Zone levels.

Do you believe it? You shouldn’t.

I didn’t do this analysis to find a bubblegum price trading strategy or make the claim that the P/BG ratio predicted the stock market. It doesn’t. I did it to make a point about all stock valuations ratios.

All stock market valuation indicators use current market price when forming a ratio. A market index price is the numerator in the ratio (the top number being divided) and then a denominator is selected to divided into it. This means only the choice of a denominator will make the difference between the results of one ratio versus another.

Denominators could be many things: trailing 12-month earnings, average 10-year earnings, book value, revenue, GDP, productivity gains and even bubblegum prices. The important aspect of a good denominator is that it’s fairly steady or else the ratio can become too volatile for use.

Since all the denominators (X) are relatively steady numbers, they’re all going to lead to the same result in a P/X comparison. One denominator isn’t going to predict market returns any better than another. When price of stock are high, all the P/X ratios are high and forecast lower 10-year returns. When the stock market is low, they’re all low and forecast double-digit gains.

In recent months, a lot of attention has been given to a certain valuation ratio that uses trailing 10-year earnings as the denominator. There has even been market-timing exchange-traded fund strategies created around using 10-year earnings as a trigger.

I’m not convinced that trailing 10-year earnings is a better indicator of future stock market performance than any other denominator may be, including bubblegum prices. All I can tell you is that the Bubblegum Ratio is below the “Pop Zone” — and that’s something to chew on.