Everyone’s Talking Bubbles. Is It Time To Act?

A leading Chinese financial official is doing it. Market columnists in the US are doing it too. Perhaps the only question left: Who’s not chattering, worrying and otherwise obsessing over market bubbles these days?

You may have to dig deep to find a bubble-free discussion. To be fair, the US stock market appears stretched. Deciding if it’s in a bubble is another matter. Even harder: If there is a bubble, is it in imminent danger of bursting? The stock answer, as always: Maybe.

There’s plenty of intelligent things to say about market bubbles – but there’s even more dross. Let’s save you some time. Perhaps the single-most useful observation comes from Barry Ritholtz of Ritholtz Wealth Management: “Bottoms are easier to spot and harder to act on; It is easy to see a ‘false top,’ and much easier to act on it.”

Most observers agree that there’s a glut of data suggesting that if the market isn’t in a bubble, it’s certainly expensive. Or perhaps it’s safer to say the market’s not cheap. Whatever the appropriate label, the numbers speak clearly, as Bloomberg columnist John Authers helpfully points out with several charts profiling the market’s ascendance of late in relative terms.

For example, the cyclically adjusted price-earnings multiple (CAPE) designed by Professor Robert Shiller is flying high these days. “By my back-of-the-envelope calculation, the CAPE is back above 35 for only the second time in history, a figure that is hard to ignore,” Authers observes.

(Click on image to enlarge)

Ray Dalio, who runs the hedge fund giant Bridgewater Associates, recently outlined six tests for assessing bubbles in our midst:

1. How high are prices relative to traditional measures?
2. Are prices discounting unsustainable conditions?
3. How many new buyers (i.e., those who weren’t previously in the market) have entered the market?
4. How broadly bullish is sentiment?
5. Are purchases being financed by high leverage?
6. Have buyers made exceptionally extended forward purchases (e.g., built inventory, contracted forward purchases, etc.) to speculate or protect themselves against future price gains?

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Disclosures: None.

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