By Robert S. Bacarella | January 5, 2021
Just like blowing up a balloon, a market bubble starts off small and gradually increases in size with the rapid escalation of stock prices. And like Glinda in her floating bubble, a market bubble draws many people to it. A market bubble involves a lot of people—with their hopes and dreams—crowded into a space that’s way too small to accommodate everyone.
But unlike the Glinda’s bubble, a market bubble can burst. The larger the bubble becomes, the greater the probability of a pop—though the size of the bubble, by itself, doesn’t mean it will burst. A market bubble burst can literally wipe out years of profitable returns and require years to recover. Experiencing the “pop” can feel like an ominous roller coaster drop. It happens quickly, you know you can’t get off. Your heart is pounding, your stomach drops and you scream until it’s over.
Predicting the precise top and/or subsequent moment when a market bubble could burst is nearly impossible. Historically, there has been no news story or rumors that preceded a bubble pop. A market bubble can last a lot longer than many people think, as the largest group of investors, by far, are those who are actually inflating the bubble. These investors tend to ignore historical valuation levels, have an “it’s different this time “mentality and believe in a “new normal” investment environment.
Though you likely can’t predict when a market bubble will burst, you can remain vigilant in watching for the “pin.” Here are two signs that may suggest the end is near:
- Performance of the leading stocks and sectors begins to lag overall market returns.
- Stock prices advance in a parabolic, upward slope as investors afraid of missing out pile in.
The secret to navigating through a bubble period is to stay focused on price action—specifically, tracking a particular stock price relative to changes in the overall market. A sector or stock that begins to lag overall market performance should be trimmed or sold…and may be a harbinger of things to come.
Once a bubble has burst, don’t panic, but start hunting for bargains…these are usually the best time to invest.