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What is a Stock Market Bubble? Are we in one?

What is a Stock Market Bubble? Are we in one?

Stock Market
22 Nov 2021

There is much discussion as to whether the stock market has entered bubble territory.  Stock market bubbles are exactly as they sound.  A bubble forms when stock prices inflate to unsustainable and unreasonable levels.  These egregiously high prices eventually pop the metaphorical bubble, causing a significant market-wide or sector-wide decline.  

Some economists argue that currently, elevated stock prices are somewhat justifiable considering the ongoing inflation that has no end in sight.  

Are we really in a stock market bubble?  Let’s find out.

Why the Stock Market Might be Bubbling

Stock market bubbles occur when market participants experience an illogical suspension of disbelief, allowing speculation and momentum to send stock prices higher and higher.  It is only when the bubble bursts that market participants recognize it is the bubble itself as opposed to the fundamentals of stocks that caused prices to escalate in the first place.

  

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There is a meritorious argument to make that we are currently in a stock market bubble that has the potential to pop in the financial quarters ahead.  The combination of low interest rates that encourage wanton borrowing, including risky borrowing on margin, combined with inflation and economic stagnation appears to have created a stock market bubble.  However, the size of this bubble is unclear.  The market bubble could gradually shrink or it could quickly burst, sending stock prices tanking to the point that trading is halted.

The Herd Mentality

Part of the reason why stock prices continue to soar is cash-rich individuals have precious few options to expand their nest egg without losing value amidst ongoing inflation.  Real estate properties are selling at record prices in a week’s time or less.

Cryptocurrencies have soared to potentially unsustainable heights in a short period of time.  Though CDs, money market accounts, and interest-bearing bank accounts provide returns, those returns are unlikely to keep pace with continued inflation following the cash-printing bonanza at the federal level in response to the pandemic.  

Precious metals and commodities haven’t generated as much investor interest as most economists anticipated.  Stocks have served as a safe haven of sorts, providing investors with gains that offset currency devaluation stemming from inflation.  Investors watched the competition pour money into stocks across industries, make quick money, and promptly followed suit, sending stock prices higher and higher.  

The uncomfortable truth is a growing number of investors view the stock market as a short-term money-making opportunity with parallels to virtual casinos.  Some retail investors who bought stocks toward the beginning of the pandemic are convinced they can beat the market, perfectly time their exit ahead of the pack’s eventual departure from these popular securities then re-establish new positions after the market inevitably dips.  

The rush into stocks has steered those patiently waiting on the sidelines for potential market pullbacks to enter the foray, ultimately moving securities prices even higher than the most bullish of analysts anticipated.  This is precisely why economists, market analysts, and the heads of financial institutions insist we are in a market bubble.  The extent of the bubble’s size and the timing of its eventual pop should concern investors at both the retail and institutional levels.  

A gradual market selloff across several months or financial quarters will slowly pop the bubble, providing investors with an opportunity to exit positions at a measured pace.  Alternatively, there is also the potential for a dramatic market selloff in response to negative economic news that prompts analysts to sound the alarm, steering shareholders toward the exits in unison. 

Recognize the Difficulty in Identifying Market Bubbles

Though stock prices are at an all-time high, much of the upward movement is the result of the devaluation of the United States dollar (USD) as a result of the highest rate of inflation in more than 30 years.  The devaluation of the dollar makes money worth less, ultimately hiking share prices all the more.  However, currency devaluation does not necessarily indicate that there is a stock market bubble.

The last major stock market bubble occurred in the late 90s and early aughts when the Nasdaq index jumped more than 400% in less than half a decade.  The “dot com” bubble burst in the early aughts, sending tech stocks downward in what became a bear market.  However, if we are currently in a similar stock market bubble, there is no guarantee it will cause a market-wide decline anywhere near the 75% decline as occurred when the Nasdaq index tanked in the period noted above.  

Some analysts insist the bubbles are more sector-based as opposed to market-wide.  Renewable energy stocks and electric vehicle stocks have soared in recent years compared to the S&P 500. Therefore, it is logical to argue a potential bubble burst will affect stocks in sectors that have grown 500+% in prior years, sparing securities in sectors that have produced modest gains in this period of time.  

The Ramifications of a Stock Market Bubble Burst

If the stock market has bubbled, the eventual burst could be viewed as logical, healthy, and also as an opportunity for additional investment.  A burst bubble could present an invaluable opportunity to establish new positions in stocks across diverse industries and risk levels.  Though your portfolio may take a short-term financial hit with a market bubble burst, it should not provoke an emotional knee-jerk response in which you unload your holdings at comparably low prices.  

The moral of this story is a stock market bubble burst should not mean much to your financial plan and net value as time progresses.  The short-term reduction in wealth will certainly sting yet it may not make a meaningful impact on your financial picture unless you established positions in stocks at the height of the market and plan to retire within a couple of years or less.  

The Market Will Rise Across Posterity

Every investor should be aware of the fact that significant market declines are tempered by halts in trading.  A significant selloff will prompt a temporary market pause so investors can reevaluate the cause of the decline and make investing decisions grounded in reason and logic as opposed to emotion and market momentum.  

Though there is certainly the potential for the selloff to continue in the ensuing months and even quarters to follow, there will also be an opportunity to pivot to other stocks, ETFs, and/or mutual funds in response to market dynamics.  The fee-only, fiduciary CERTFIED FINANCIAL PLANNER™ Professionals at McGervey Wealth Management located in Canton, OH are here to help you strategically position your money accordingly, providing protection against market selloffs without minimizing potential upside when the market pendulum inevitably swings back in favor of the bulls.

Stock Market Guidance From an Experienced Financial Advisor in Canton, OH is a Call Away

If you are worried about a potential stock market bubble, we can help! Instead of searching the web for “how to choose a fiduciary” and spending hours sorting through the results, reach out to the CERTIFIED FINANCIAL PLANNER™ Professionals at McGervey Wealth Management. By working with a fiduciary like McGervey Wealth Management, you can be assured you’re getting investment advice and investment management that addresses the potential for significant market corrections. 

At McGervey Wealth Management, we get to know you on a personal level and keep things simple, using common language everyone can understand. To learn more about ways you can protect your portfolio from stock market bubbles call (330) 493-9300 or contact us today.

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More About the Author: E. Michael McGervey, CFP®, CRPC®

Mike is passionate and skilled at helping clients solve complex financial challenges. He’s known for his thoughtful communication, educational approach, and exceptional customized service. Mike has been a sought-after source for financial television, magazines, and newspapers looking for insightful analysis. His expertise has been featured by CNBC, FOX Business and...