How do you Spot a Market Bubble?

How do you spot a market bubble?

1. Identify excessive valuations, these can be measured. The case studies analysed in previous videos showed examples:
   • A single tulip bulb being worth more than a huge package of commodities.
   • Stocks trading at huge price-earnings ratios, or at huge prices when there are no earnings at all.

2. Analyse the investor base
   • Has the asset found a home with end investors, or are the buyers speculators loaded up with leverage?

3. Look hard at the new technology or innovation that is supposed to be so valuable.
   • Does it really have so much potential? It is a matter of knowing not to overpay for an asset that has got ahead of itself.

4. A subjective way of gauging a bubble is listening to the way people are talking about a market.
   • In a bubble everyone is hooked, from taxi drivers to shoeshine boys. The press is full of coverage. Many people will have no doubts, and preach about the market with an evangelical zeal.

What should you do about a bubble?

1. Stay out
2. Buy a small amount of the asset. If the market continues to soar, you get big gains. If it goes to zero you’ve lost an amount you can live with.
3. Invest in other assets that will do well when the bubble bursts. When stock markets seem too high, investors can consider assets including bonds, real estate, and metals. Stock sectors that often perform well in a recession include medical care, household items, electricity, and food - which people must continue to buy.
4. Short the market. However, this is a dangerous strategy as a short position would be fighting a powerful trend.