Tags: Light | stock | signs | bubble

WSJ's Light: 3 Signs of a Bubble in Financial Markets

By    |   Monday, 21 April 2014 09:09 AM

It's not always easy to determine when the prices of stocks or some other asset are merely expensive or when they're in a bubble, according to Joe Light of The Wall Street Journal.

"Prices can be both 'not cheap' and 'not in a bubble,'" Vikram Mansharamani, a lecturer and bubble expert at Yale University, tells Light.

Light cites three developments that often presage a bubble.

Editor’s Note:
5 Shocking Reasons the Dow Will Hit 60,000

"The first sign of a potential bubble, and the easiest to spot, is a rapid rise in prices," he says. For example, the Nasdaq Composite index soared 110 percent in the year through March 10, 2000, when it peaked.

The price jumps also are frequently interrupted by panicked spates of selling, Didier Sornette, director of the Financial Crisis Observatory at the Swiss Federal Institute of Technology Zurich, explains.

"Another warning sign is when prices break sharply from an asset's underlying value," Light writes.

The third bubble warning is when investors cite a technology or innovation that explains rapidly advancing prices, such as the Internet in the late 1990s, the Bank of Finland's Katja Taipalus tells Light.

While some are warning the stock market is in a bubble now, "on closer inspection, it is clear that U.S. stocks can't be called a bubble — at least not yet. To begin with, the Shiller P/E [price-earnings ratio] of the S&P 500 is 25. That is higher than the historical average, but far below the dot-com era peak," Light explains.

"Bubbles are rare, which means it is uncommon to find assets displaying all of the warning signs at once. But investors also should keep an eye on assets that show one or two of the common red flags," he warns.

Some analysts view the 138 percent increase by the Russell 2000 index of small stocks during the past five years as a bubble.

"Small-cap [stocks] looks very expensive," Matt Kadnar, a portfolio manager at GMO, tells InstitutionalInvestor.com. "If there's a bubble anywhere in the stock market, it's in small-cap."

Based on P/E ratios, profit margins, growth and income, the Russell 2,500 index of small-cap and mid-cap stocks is more expensive than any time since the early 1990s, Kadnar says.

Editor’s Note: 5 Shocking Reasons the Dow Will Hit 60,000

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InvestingAnalysis
It's not always easy to determine when the prices of stocks or some other asset are merely expensive or when they're in a bubble, according to Joe Light of The Wall Street Journal.
Light, stock, signs, bubble
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2014-09-21
Monday, 21 April 2014 09:09 AM
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