If you’re not paying attention, stock market bubbles will sneak up on you and destroy your wealth. They’re deceptive, unpredictable and ruthless. When that day comes, it’s too late to prepare. Luckily, bubbles have a few defining characteristics to help you not only identify when one is coming but how to get out without losing your shirt. For example, price is trading higher than what its value actually is. Therefore, the fundamentals don’t jive with price. And a bubble forms.
Is a Bubble Forming in the Stock Market?
Is a stock market bubble forming? People have said yes for years. And they’re not wrong. Our debt is increasing and we’re printing money hand over fist. How is this helpful to a strong economy?
It’s not. But doing that can keep the bubble from popping. The fear with that though, is a bubble can’t keep growing forever. So it will have to pop. And when it does, it could be disastrous. After all, like the song says, “the bigger they are, the harder they fall.”
And if we keep blowing up the bubble to push out a bear market, the bigger the pop when it happens. Bear markets aren’t a bad thing though. They keep things from becoming overpriced.
If you know where to invest in a bear market, then you have nothing to worry about. And at that point, maybe we wouldn’t have to keep blowing up the stock market bubble.
What Is a Stock Market Bubble?
During a bubble, stock prices often surge to the moon. Consequently, so does your portfolio, and retirement goals of golfing and fishing are within reach. Your ten-year plan just got cut back to five. But, as you know, what goes up, must go down.
And when the bubble burst, the fall from grace is swift and ruthless. Not only will you not be golfing next year, but you may also have to get a job as a caddy for the next 10.
To prevent yourself from getting caught in its deceptive clutches, you must be woke. What I am saying is, wherever your money is, you need to be there too. If you don’t take an active role in your financial planning – which includes watching for stock market bubbles – you’re at rave risk of seeing your retirement dreams go down the drain.
5 Minute Takeaway
- – In the economic context, a bubble is when the price for something – a stock, financial asset class or even the entire market is grossly overpriced compared to its fundamental value.
- – We have four different financial bubbles: stock market bubbles, market bubbles, credit bubbles, and commodity bubbles.
- – The five steps of a stock market bubble are displacement, boom, euphoria, profit-taking, and panic.
- – The fallout’s extent from the bubble bursting depends on a few different factors. First and foremost, the economic sector(s) where it’s occurring. Or whether or not the bubble is localized or worldwide. Finally, the extent to which extended credit fueled the investments that created or inflated the bubble in the first place. Look no further than the housing crisis of 2008 for proof of that.
Again, if you’re not woke and don’t follow the markets, you probably won’t notice a market bubble until it’s too late. A famous investor once said the single most dependable feature of a great bubble is really crazy investor behavior, especially on the part of individuals.
Go on YouTube, and you can find proof of this in action as we speak. Or even better, I urge you to draw your attention to Signal Advance, a small medical company whose shares rose 11,700% in just three days. All because of one mistyped and misunderstood tweet.
Yes, just a two-word tweet sent by Elon Musk was all it took to send Signal share prices to the moon (no pun intended). He meant to tweet, “Use Signal as an alternative to WhatsApp.” Instead, he fired off a tweet that said, “Use Signal” and people did just that. Check out the image below for proof.
How Do You Spot a Stock Market Bubble?
- Panic selling
When panic selling occurs, that’s when a crash happens. Mass selling scares people. You can either hold through the selling because what goes up must come down. Or you can sell and buy back cheaper. There is no right or wrong answer. It just depends on if you want to lose and how much you want to lose.
If you buy at support and sell at resistance each time a stock moves, then you’re not stuck panic selling usually. However, if you’re investing, then you should have safe havens and stock sectors that do well in a bear market to protect yourself.
Stage 1: Displacement
The first stage of a bubble is displacement. Displacement occurs when investors and speculators become entranced by new technologies and paradigms. Say, for example, bitcoin or historically low or rock-bottom interest rates we are currently experiencing. In turn, the value of assets starts increasing here as the seeds for the bubble begin to sow.
Stage 2: Take Off
The second stage is take-off. Interest in investing begins to increase as more and more people start to enter the market. Consequently, because of the demand, the price of assets start to gain momentum, setting up the boom.
People will buy anything at any price if there seems to be some action in progress. Look no further than leading assets like Tesla or cryptocurrency.
Once they started attracting widespread media coverage, the fear of missing out on that one trade that could free you from the financial shackles yields wild speculative purchases. Fomo trading is real.
If this investor does not do his due diligence, he speculates on the hope that another fool will pay an even higher price than he did. A lot of new traders do this. Just look at the meme stock explosion.
Stage Three: Exuberance
The third stage in a stock market bubble is exuberance. Right now, using the bubble model, it appears we are in this stage, maybe even the tail-end. In this stage, there is an unsustainable euphoria. People claim that certain stocks will 10x with no risk.
Risk tolerance completely goes out the window as prices reach record highs. Fake and misleading metrics are used and invented by speculators to justify this rise and how it will be sustainable, bringing rise to The Greater Fool Economic Theory. What’s that?
There will always be a buyer or “fool” willing to pay more no matter how high the price. Prime examples of this are the 1989 Japanese real estate bubble, the internet bubble of 2000 and maybe even the bubble of 2021. At its peak, Tokyo’s office space sold for as much as $139,000 per square foot, no joke! Similarly, at the height of the .com bubble, all tech stocks’ combined value on the Nasdaq was higher than most country’s GDP. Crazy.
Stage Four: The Critical Stage
This stage is where profit-taking occurs, and sellers start to sell positions and take profits. Despite the potential for further price increases, wise investors heed warning start to sell their positions and take their profits.
We cannot predict what the future will bring. It is entirely possible the bubble may burst in a year or two from now. And yes, we may have made greater returns if we held our speculative assets and growth stocks until just before the bubble popped. However, no one has a magic ball, and not picking up the critical stage signs would be a gross neglect of risk.
Stage Five: The Crash and Panic
During the crash and panic stage, prices plummet, and investors and speculators alike feel the panic and need to sell all their holdings at any cost.
This mania causes supply to dwarf demand leading to faster drops in price—quite the opposite of what they expected.
Many signs are pointing towards us being in the euphoria stage of a stock market bubble. And many experts and non-experts say we are in a stock market bubble that will burst very shortly.
Did you know you can invest in a bubble and when the market is both overvalued and falling? The key to both is to have a strong foundation of knowledge and the right team behind you. What’s great about Bullish Bears is that they provide you with both and will teach you to profit in any market condition. So even if a financial contagion affects us, we can trade through it.
Is the Us Economy in a Bubble?
I’m no analyst, but you can let the numbers speak for themselves. Look no further than the Buffet Indicator. The Buffett Indicator is the ratio of total the United States stock market valuation to GDP. A “fairly” valued market has a ratio of around 120%.
As of March 25, 2021, the Buffet Indicator sits at 225%. Furthermore, the current market-to-GDP ratio is 79% above the historical average. This is more the historic exuberance of the .com bubble and suggests we are highly overvalued. According to the indicator, this crash could be even bigger than the drop back in March. In fact, it could even be bigger than the Great Recession.
A word of warning, though: No single metric is illustrative of the entire market. Many point out a flaw in the Buffet Indicator in that it doesn’t take into account the state of non-equity asset markets. In truth, investors have many different asset classes to chose from – e.g., corporate bonds, real estate, and commodities.
If and when the crash does come, you can make money by buying the dip. Of course, you can make money riding it down by shorting. Why don’t you check out our videos on shorting and how it’s not that hard to do. This leads me to my next point…
Buying the Dip
It’s doesn’t take a rocket scientist to know that money is made when you buy low and sell high. Obviously, you want to buy stocks once they’ve hit rock bottom to ride the wave back up. However, the bottom is hard to pick. In many cases, we first see a run-up, then the test.
People who got the big picture right might see much higher prices by the end of the decade. But first, they’d endure a month where the price drifted lower before taking off. The test is always painful. Many people can’t handle it.
They sell, walk away, and try to forget about the idea entirely. It’s my belief, the more intense the test, the more spectacular the rally. The reward comes to those who get it right and have patience. If you’re going to dip buy, you need to make sure it’s the dip. So you don’t buy and it keeps on dipping.
What Is an Asset Price Bubble?
Stock market bubbles are a result of a perfect storm of events, which include:
- -Low-interest rates that encourage borrowing for whatever reason (i.e. new house, company expansion, and investment).
- -The spin-off from low interest rates causing an influx of foreign investment and purchases.
- -New products or technologies can spur demand and, as you know, demand increases the price.
- -Any shortage in asset classes – think housing in Vancouver, LA, and NYC, which cause prices to soar. The classic supply and demand principles stand the test of time.
Stock Market Bubble Bottom Line
Major changes always give advance notice. The problem is most people don’t pay attention; they either don’t want to or can’t. After change hits, they complain and gripe and swear off investing altogether. All of which is pointless as we know the stock market is one of the greatest wealth-building tools of all time.
Sadly but truly, most people believe what they hear on the television or from a stranger they just met at a bbq. They largely can’t think for themselves. Hearing a message from a market analyst with a credible appearance encourages trust.
When it comes to spotting a change on the horizon, a tv market analyst won’t help. Worse, they could even tell you not to worry, and all will be well. The truth is, the only way to survive a stock market bubble and reset is to think for yourself. The clues appear in advance every time, are you woke?