We Are Now Officially In A Stock Market Bubble

“Double, Double, Toil and Trouble

 Fire Burn and Cauldron Bubble

 By the Pricking of My Thumbs

 Something Wicked This Way Comes”

-Shakespeare's Macbeth (Act IV, Scene I)

It has often been said that asset bubbles can’t be identified except in hindsight. I disagree. But I do agree that bubbles can continue to inflate for months or years after they are first identified. This is where we are today.

We are now in the most overpriced market in history, bar none. We can, and probably will, go higher as the speculative juices of investors cause them to continue to buy equities with little regard for valuations or market history.


Irrational Exuberance

Perhaps the most classic example of an asset bubble continuing to inflate for years after it was first identified came in December 1996, when then chairman of the Fed Alan Greenspan spoke these famous words:

“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

This quote was interpreted as a warning that Greenspan was worried that the stock market might be overvalued, and yet the market kept marching higher for the next four years. When this bubble finally burst in 2000, the NASDAQ fell 78% from peak to trough, leaving in its wake a slew of dotcom bankruptcies and the broken dreams of investors who thought we were in a new era of unending prosperity.

How overvalued are we?

As the below chart from Jill Mislinski at dshort shows, we are now officially in a stock market bubble. We could be in the early stages or the late stages, but it’s a valuation bubble, nonetheless. According to Ms. Mislinski,

“The peak in 2000 marked an unprecedented 129% overshooting of the trend - substantially above the overshoot in 1929. At the beginning of December 2020, it is 154% above trend. The major troughs of the past saw declines in excess of 50% below the trend. If the current S&P 500 were sitting squarely on the regression, it would be at the 1457 level.”

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Edward Simon 1 month ago Member's comment

Erik, interesting article. I enjoyed the history lesson. I think we are headed for a correction which might come as early as this week depending on the FANG gang earnings for Q4. But who knows. Of course one can’t expect people to put their cash under the mattress. What do you think are possible Investmemt vehicles other than precious metals or cryptos?

Susan Miller 1 month ago Member's comment

Good read, thanks. And welcome to TalkMarkets. Looking forward to reading more by you.