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 identify when one is coming and how to get out without losing your shirt. For example, the price is trading higher than its value. Therefore, the fundamentals don’t jive with price. And a bubble forms.
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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 bursts, 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.
It would be best to be woke to avoid getting caught in its deceptive clutches. I am saying that you need to be there wherever your money is. If you don’t take an active role in your financial planning, including watching for stock market bubbles, you risk seeing your retirement dreams go down the drain.
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. However, The fear is that a bubble can’t keep growing forever. So it will have to pop. And when it does, it could be disastrous. After all, as 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.
You have nothing to worry about if you know where to invest in a bear market. And at that point, maybe we wouldn’t have to keep blowing up the stock market bubble.
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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 several factors. First, 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 crazy investor behavior, especially on the part of individuals.
You can find proof of this on YouTube 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 three days. All because of one mistyped and misunderstood tweet.
Yes, just a two-word tweet 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 tweeted, “Use Signal,” and people did that. Check out the image below for proof.
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How Do You Spot a Stock Market Bubble?
- Displacement
- Take-off
- Excitement
- Profit-taking
- 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 depends on whether 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, you’re usually not stuck in panic selling. However, if you’re investing, 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 the 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 in 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 be 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?
A buyer or “fool” will always be willing to pay more, regardless of the price. Prime examples 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
In this stage, profit-taking occurs, and sellers start to sell positions and take profits. Despite the potential for further price increases, wise investors heed the warning and start to sell their positions and take their profits.
We cannot predict what the future will bring. 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 plummeted, and investors and speculators felt the panic and needed 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 point to 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 shortly.
Did you know you can invest in a bubble when the market is overvalued and falling? The key to both is having a strong knowledge foundation and the right team behind you. What’s great about Bullish Bears is that they provide 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 Stock Market 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 the total 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 is 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. It could even be bigger than the Great Recession.
A warning, though No single metric illustrates the entire market. Many point out a flaw in the Buffet Indicator: it doesn’t consider the state of non-equity asset markets. In truth, investors have many different asset classes to choose from – e.g., corporate bonds, real estate, and commodities.
You can make money by buying the dip if and when the crash does come. 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 doesn’t take a rocket scientist to know that money is made when you buy low and sell high. 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 decade’s end. 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 the idea entirely. I believe 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 must ensure it’s the dip. So you don’t buy, and it keeps on dipping.
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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 caused 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 causes prices to soar. The classic supply and demand principles stand the test of time.
Final Thoughts: Stock Market Bubble
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?