What Is a Stock Market Bubble?
A stock market bubble occurs when investors drive stock prices above their true market value.
Remember, markets are a reflection not only of investor calculations, but also of investor emotions and beliefs.
The dot-com bubble of the late 1990s is a classic example. People speculated on the development of the exciting, new Internet sector and began to overlook traditional metrics like the P/E ratio.
The market was so confident in tech profits that companies could simply add “.com” to the end of their names and they’d get a stock price bump.
But then companies began to run out of capital or went out of business. Executives were convicted of fraud for misuse of shareholder funds, and the SEC cracked down on venture firms for misleading investors.
The Stock Market Crash of 2000-2002 obliterated $5 trillion in market value.
Two indices just hit record highs: The Nasdaq Composite reached 5,107 on May 27, and the S&P 500 climbed to 2,130.82 on May 21.
But Nobel Laureate and Yale professor of economics Robert Shiller told Goldman Sachs on May 29 that while he isn’t certain people have the extravagant expectations you’d find in a “classic bubble,” “there is a stock bubble element in what we see.”
Typically, stock market bubbles stem from heightened expectations – but this bubble is the opposite.
Instead, people have extraordinarily heightened fears about markets right now.
“I detect a tinge of anxiety and insecurity now that is a factor in markets, which is quite different from other market booms historically,” Shiller said.
The same thing happened right before the dot.com bubble burst.
You see, Shiller frequently polls institutional and individual investors about confidence in the stock market.
He asks, “Do you think the stock market is overvalued, undervalued, or about right?”
“Lately, what I call ‘valuation confidence’ captured by this question has been on a downward trend, and for individual investors recently reached its lowest point since the stock market peak in 2000,” Shiller told Goldman Sachs.
“The fact that people don’t believe in the valuation of the market is a source of concern and might be a symptom of a bubble, though I don’t know that we have enough data to provide it is a bubble.”
When people are fearful, they tend to want to protect themselves by saving more for retirement and other safety nets.
However, they’re faced with limited options for high return.
And so they invest in overvalued equities, which in turn run up prices even more.
Money Morning Special Contributor Michael E. Lewitt has been saying stocks are overvalued since November 2014.
“Since November, I’ve predicted the U.S. economy would experience a ‘growth scare’ in 2015,” he said on March 22, 2015.
“Since then, bond yields have plunged and commodity prices have collapsed. Only stocks have failed to figure out that low growth is a recipe for coming disaster.”
Lewitt warned that just because the Fed is terrified to raise interest rates doesn’t mean investors should pour money into already overvalued stocks.
Bottom Line: Are we in a stock market bubble?
We are, in the very least, flirting with one. Lewitt recommends investors take immediate steps to protect their portfolios from losses.
“If you can’t bear to sell your stocks, hedge your portfolio by buying ProShares Short S&P 500 ETF (NYSEARCA:SH) to soften the blow of an inevitable correction,” Lewitt said. “Also, look to buy gold now that it has sold off due to the stronger dollar.”
No matter where markets are headed in coming months, owning gold is an important part of a healthy portfolio.
We’re in the midst of the greatest investing boom in almost 60 years. And rest assured – this boom is not about to end anytime soon. You see, the flattening of the world continues to spawn new markets worth trillions of dollars; new customers that measure in the billions; an insatiable global demand for basic resources that’s growing exponentially; and a technological revolution even in the most distant markets on the planet. And MoneyMorning is here to help investors profit handsomely on this seismic shift in the global economy. In fact, we believe this is where the only real fortunes will be made in the months and years to come.