It seems like the stock market is hitting all-time highs just about every week in 2021. While stocks have shown a serious bounce since the pandemic's start, this resilience is giving some investors pause. Could we be in a stock market bubble? Here are five signs to look for to judge whether we are in bubble-market territory and what we will likely see if we are there.
1. A story has captured the market's imagination
The dot-com bubble of the late 1990s had one: "The internet changes everything." The benefits of the internet eventually arrived, but not before effectively destroying hundreds of dot-com companies that had poor business models.
Where we see it today: There's not one widespread story that has captured the imagination the way that dot-com stocks did, but a few sectors are bubblicious: electric vehicles, self-driving cars, software-as-a-service (SaaS) companies, Uber and cryptocurrency all have similar story elements that promise radical transformation and charge a very high price of admission.
2. Prices rise regardless of news
The story is important because it offers a theme to build investors' hopes and dreams on. In a bubble, it's as if every bit of information verifies the story, so stock prices rise regardless of the news.
Where we see it today: Look at individual sectors or companies and you will see them rising to high valuations despite mediocre or poor news. For example, in December Tesla's valuation was more than the next nine carmakers together, despite being barely profitable and facing increasing competition.
3. Other asset prices are soaring, too
Flush with cash from their stock successes, a booming economy or easy money, speculators rush out to buy other highly risky assets. Promoters may try to hype up "new asset classes" by highlighting how investable sports cards are, or how art from the great masters never seems to decline in value.
Where we see it today: With thousands of possible examples, cryptocurrencies have seen a flood of interest as speculators and promoters rush to the space to cash in. NFTs are riding this wave as well.
4. New traders say that old investors 'don't get it'
This new breed of trader will explain to you why Warren Buffett doesn't "get" the new paradigm and that Buffett and other similarly "old school" investors are behind the curve. This new crowd may have been trading for just a few months, but they insist they understand the markets.
Where we see it today: While SaaS companies promised and delivered high revenue growth in 2020, they are often not nearly so profitable (yet) to justify valuations. It's a similar story for cryptocurrency, the Coinbase IPO and unprofitable car-hire services such as Uber and Lyft.
5. Stock valuations in the top percentiles
It's important to recognize that a price rise alone is not sufficient to say something is in a bubble. A stock can rise 100% and not be in a bubble if its underlying fundamentals have improved significantly.
Where we see it today: Despite the market's strong run, stocks don't appear clearly in a bubble. If we decide to measure off 2020s lows, we may get an errant sense that the market is being carelessly optimistic, when it's really being somewhat more positive than the usual year. With all the money flowing into the economy from stimulus and the Fed, is that unreasonable?