Bridgewater doyen, Ray Dalio, takes on the quadrillion dollar question today. Are stocks in a bubble? He breaks it down via series of measures that breaks out a cohort of “bubble stocks” while the broader market is only expensive. This looks to me like Mr Dalio is arguing that we have K-shaped bubble, if you will pardon such a tortured expression. If so, it is plausible that we see the two arms of the “K” converge and, rather than an overall bubble pop, we see a violent rotation, from growth to value.
I’ve seen a lot of bubbles in my time and I have studied even more in history, so I know what I mean by a bubble and I systemized it into a “bubble indicator” that I monitor to help give me perspective on each market. We now use it to look at most markets we are in. I want to show you how it works and what it is now showing for US stocks.
What I mean by a bubble is an unsustainably high price, and how I measure it is with the following six measures.
- How high are prices relative to traditional measures?
- Are prices discounting unsustainable conditions?
- How many new buyers (i.e., those who weren’t previously in the market) have entered the market?
- How broadly bullish is sentiment?
- Are purchases being financed by high leverage?
- Have buyers made exceptionally extended forward purchases (e.g., built inventory, contracted forward purchases, etc.) to speculate or protect themselves against future price gains?
