How to Tell if a Stock Market's in a Bubble

Is it a bubble? Isn’t it? When is it one? What’s going on with the stock market, anyways? I’m going to teach you the classic signs of a bubble. Some of them are even going to be funny. Let’s begin with number one, the biggie.

1. Normal people become weirdly obsessed with the stock market. Suddenly, totally regular people who aren’t creepy finance dorks, meaning who usually check their portfolios maybe once a year…are now checking, biting their nails, hearts racing, fingers crossed, every morning, every evening, several times a day. Look, it’s not remotely healthy or wise for anyone vaguely normal to be OCD fixated on the stock market like American Psycho. When mild-mannered teachers with MFAs, barely-employed 19 year olds, NFL-watching middle manager dudes, and cool old ladies who like Paris and art are out there sweating the numbers by the microsecond like everyone suddenly got possessed by Bernie Madoff? That’s the surest sign that we’re in bubble territory. These days, I can’t speak with my American friends, or scan the headlines, without it. This is mania, and it’s the truest sign of a bubble.

2. (Really) bad news about the economy ceases to matter. How much bad news has there been in America? Every kind imaginable, and then some. The labor market created zero jobs over the summer. The President is trying to take over the central bank, not to mention cook the books. The dollar’s losing its reserve currency status. The effects of the tariffs are starting to bite, and prices rising. I could go on and on. Stock markets are made of economies, not the other way around, and when they forget that, then we’re in bubble territory. This is frenzy, in which we willfully ignore what we don’t want to hear.

3. Finance ceases to matter. Did you know that every major indicator of such a thing, and there are plenty of them, is saying the same thing right now? That’s right, bubble. There’s the Buffett ratio, the Shiller ratio, just basic valuations, and many more. When they all agree that the market is in bubble territory? Come now. This is euphoria. And it’s what leads to historic crashes. 

4. Everybody’s telling you to buy, and nobody’s telling you to sell. This is groupthink, and it’s another telling sign of a bubble. Think carefully: is there anyone out there telling you not to buy, buy, buy? From financial influencers to financial advisors to those dorks on TV? And when did we hear that? 1929, 1987, 1999, and I could go on, right back to the Dutch tulip bubble. Remember everyone suddenly acting like, LOL, American Psycho? “Sell” in this case doesn’t necessarily mean liquidate, but it does mean: assets other than stocks, which aren’t as risky. And risk is the point here, because…

5. When risk appears not to exist, and what is risky is said to be riskless. Let me illustrate this one with a recent story:

“Oracle (ORCL) stock jumped over 36% Wednesday to a new record close.”

So. Oracle stock jumped by 36% in a matter of minutes. An enormous number. Why? 

“We expect Oracle Cloud Infrastructure revenue to grow 77% to $18 billion this fiscal year — and then increase to $32 billion, $73 billion, $114 billion, and $144 billion over the subsequent four years,” CEO Safra Catz said in a statement on Tuesday. Oracle stock’s rise Wednesday was its biggest single-day gain since December 1992.”

Oracle’s CEO described this nice dream of revenues jumping almost ten times in five years. And…bang. Let’s actually think about that for a second. Even if you buy that such a flimsy projection—and that’s all this is—is possible, surely you should be assigning some level of risk to it. But nobody here is doing that. The market just sort of heard this number, which is more or less picked out of thin air, and exploded in a roar of delight, believing: this is 100% certain!

Blind faith. This is the kind of thing that should give you pause. If someone, anyone, came to you with a business plan that said “I’m going to magically multiply your money by ten times in five years,” you’d probably laugh at them. Every single serious investor I know would, and that includes many of the world’s major ones. This is the stuff that laughably bad business plans are made of, in fact it’s the very first textbook mistake, the 10x-in-5- years vision, so much so that it’s a cliche they teach you not to pitch in every decent business school.

(That is because such opportunities are rarer than needles in a haystack, and usually, it’s only the fabled “unicorn” of a startup that even begins to do it, and even then, they usually take ten to twenty years. )

So this kind of startling explosion isn’t just irrational. It tells us that the people buying aren’t considering risk, aka, the probability that this paper-thin projection is  less than 100% certain. Which in this case, funnily enough, is the most elementary b-school pitch mistake of all, the 10x-in-5-years fairy tale.

In cases like this, people are ignoring the fundamentals of investment, not even in stocks, but in businesses, or any enterprise, period. Aren’t even bothering to think for a moment about the numbers involved, and whether or not they’re plausible, or what happens, if for example, they don’t grow by ten times in five years. Or that they don’t even stay on that path next year. 

See why I laid out this little case study for you? When we encounter markets blindly believing the bad cliche of a fairy tale like 10x-in-5-years being 100% true, the very one we use to teach people how not to invest, or even pitch investment, then my friends? Every last principle of reality, history, finance, economics, or even just plain old common sense appears to be being chucked cheerily through the nearest window.

Let me emphasize the last principle here for you. When what is risky appears to riskless. When risk appears not to exist at all. When it’s just buy, buy, buy, because nothing can go wrong. That is when we’re in a bubble. Because the truth is that nothing in life, ever, is riskless. 

These days? Even American Treasury Bills are risky, since, of course, Trump is treating the US economy like one of his businesses, and is probably going to default, and pretend not to. If T-bills are that risky—if the dollar itself is risky—then pretending that stocks aren’t is mighty foolish indeed.

Maybe I’m wrong. Maybe the American stock market is now an invention that never existed before in history: a perpetual magic money machine. Do you buy that? It’s OK. I saw it. A little demon, burning bright green, perched right there on your shoulder, telling you: but it could be! Couldn’t it?! Buy, buy, buy! And that, my friends, is the surest sign of all that we’re in a bubble. Greed.

When everybody is taking risk, and calling it riskless? Blindly? Thoughtlessly? Carelessly? Just because everyone else is doing that? That is exactly when you don’t want to be. 

Be careful out there. And if you’re checking your portfolio every day? More than that? It’s unhealthy. Don’t do it. Instead, build confidence, gain knowledge, and listen to your intuition—so that you can create real wealth without depending on bubbles, and risking crashes. 

Love,

Umair (and Snowy!)

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