How do you know if there’s a stock market bubble?
The thing about asset bubbles is that you only know for certain that they were there when they’ve popped.
But still, there are signs that you can look for.
What are those signs?
I’ll take you through the top 10 signs that are showing right now.
1. Individual Companies’ Stock Soaring
As Tesla’s stock reached new heights in January, Tesla’s founder Elon Musk became the richest man on earth.
“How strange,” he wrote in a comment on Twitter, and a second later: “Well, back to work.”
Even he is astonished at what’s going on.
Tesla’s market cap is higher than Toyota, Volkswagen, GM, BMW, Daimler, Honda, and Ford combined, despite the fact that their combined revenue is 36 times higher than Tesla’s. On top of that, Tesla is struggling to make a profit.
Tesla’s P/E has surpassed 1500. A reasonable level for an average company would be 15.
A P/E of that level means that you pay 1500 USD for 1 dollar of earnings.
2. IPOs Skyrocketing
IPOs are more frequent in times when the stock market is doing well. That makes sense. Who would want to sell their life’s work in a depressed market?
However, what’s unusual is the way the market receives IPOs these days.
Shares in Airbnb more than doubled on the first day of trading in December. They went from 68 USD per share to 148 USD per share.
Even new issues of small companies with no revenue might shoot through the roof. A lot of it is due to private investors gambling that it will shoot up precisely because it’s an IPO.
3. Bloggers and YouTube Stock Channels Exploding
YouTube videos that promise “hot stocks to 10x your money” can get half a million views in days.
Newbie investors quit their jobs to make Y0uTube videos about stock investing. They can make a better living off the ads from their videos – even if they have nothing more to say than to explain how to open an account and buy Tesla shares.
This tendency is a sign that people are searching for this information and that advertisers are willing to pay a lot to get some airtime with the stock-interested audience.
4. Your Cab Driver’s Favorite Subject Is His Stocks
I remember some taxi rides before the financial crisis that puzzled me.
I was a news journalist, and I took a lot of taxis going back and forth from press meetings to the newsroom.
The cab drivers in 2007 and 2008 loved talking about flipping houses and how much money they made buying houses, renovating them, and selling them.
The barista, the hairdresser, and the cab driver have another favorite subject these days. They love talking about stocks where they made a quick buck.
They’re investing their savings, betting on a quick gain, and exiting. They aren’t investing for their retirement. They’re gambling and betting on a quick in-and-out to make money in a few weeks.
5. Lots of New Trading Accounts
Robinhood, a trading platform popular with teenagers, opened more than 3 million new accounts in 2020.
In my home country of Denmark, Nordnet, a platform that targets young people, gained 80,000 customers in 2020 and increased the total number to 200,000. It’s really impressive if you think about it.
6. New Investors Talk About the Old School Having Lost the Touch
Warren Buffett had a tough time during the dotcom bubble.
The number of attendees at Berkshire Hathaway’s annual meeting dwindled. One person even had the guts to take the microphone and ask if “he didn’t have enough brain cells to pick one or two tech stocks.”
Value investors are scorned whenever there’s a bubble. When you invest with reasonable valuations as criteria, you’ll miss out on some of the fun when the going gets exuberant.
If you hear people say that Warren Buffett has “lost it”, you should actually pay attention. It’s a sign. The market is foaming with greed. There’s no longer patience with a reasonable approach.
7. A Penny Stock Can Soar 6,000 Percent on a Misunderstanding
In January, Elon Musk said that he’ll stop using Facebook’s WhatsApp and instead migrate to the donor-based, open source messenger service called Signal.
Signal is not on the stock market, but another company called Signal Advanced is.
Signal Advance’s stock surged from 0.60 USD to more than 60 USD in a few days. It has since settled, but the fact that it exploded on a misunderstanding says a lot about both the frothy state of the market as well as the psychological makeup of Elon Musk’s and Tesla’s fan base.
8. “This Time It’s Different”
Whenever there is a bubble, there’ll be justifications and some kind of theoretical explanation of why gravity has stopped working.
It happened in 1929 (the excuse was modern inventions), during the dotcom-bubble (the excuse was the internet) and before the financial crisis (this time the excuse was that migration to the cities justified forever-rising real estate prices in certain areas).
It’s also happening now, with the main line of argument being that interest rates will never go up, and therefore there’s no alternative to investing in stocks.
These arguments can sound as far-fetched as conspiracy theories, but their proponents are very verbal and insistent.
If you hear someone explain that “it’s different this time” or “times have changed”, pay attention. It’s one of the signs.
9. Shiller P/E Above 30
The Nobel prize-winning economist Robert Shiller warned that markets can become irrationally exuberant. The Shiller P/E ratio measures the market’s level of sanity or insanity.
Right now it’s above 30 – which it has only been three times in history: During 1929, during the dotcom bubble, and now.
In 1929 it reached 30. Right now it’s at 34.
Did you know that it took 29 years before the Dow Jones reached the same level it was at in 1929? That means you’d be almost 30 years older before your money was worth the same.
10. Buffett Indicator at All-Time High
Warren Buffett says that the single best measure of where valuations stand is comparing the market cap to GDP.
The Buffett indicator takes the very broad index called Wilshire 5000 and holds it up against GDP.
What does it show? Well, it’s never been higher. It should be around 50-75. If it reaches above 90, the market is in bubble territory.
It’s not only above 100 – it’s around 200.
It has never been that high before.
Maybe it’s not so strange that Warren Buffett holds around 130 billion dollars in cash (or cash equivalent).
What do you think? Is Warren Buffett being prudent, or has he lost the touch?
You’ve probably figured out that I’m on team Buffett. Which one are you on?
Don’t forget to read my free e-book that explains my whole investing process – including my favorite way to calculate what a company is worth. You can get it here.