Identifying the Bubble

The Indian markets benchmarks Sensex @29000 and Nifty moving towards 9000 mark, has the music begun, has blogthe party started? Many of the Market Bear analysts have already cautioned the move.  Too much information these days in market is extremely dangerous.

Has the bubble formation started how long it will last, to be honest I don’t know. Bottom line the long-term story remains bullish and if you are in quality stocks you will get returns.

So how do we identify the bubble problem, the problem with bubbles is that if you sell stocks before the bubble bursts, you look foolish, but you also look foolish if you sell stocks after the bubble bursts.

Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.” — George Soros 

It’s easy to read then identifying in the real life, Yale professor Robert Shiller outlined how to identify bubbles in his seminal book, Irrational Exuberance (As you will read, there is some overlap in our identification process of bubble finding):

  • The sharp increase in the price of an asset or share class
  • Great public excitement about these price increases
  • An accompanying media frenzy.
  • Growing interest in the class among the general public
  • New Era‘ theories justifying the high price
  • A decline in lending standards

Some other conditions leading up to bubbles identified

  1. Debt is cheap.
  2. Debt is plentiful.
  3. There is the egregious use of debt.
  4. A new marginal (and sizeable) buyer of an asset class appears.
  5. After a sustained advance in an asset class’s price, the prior four factors lead to new-era thinking that cycles have been eradicated/eliminated and that a long boom in value lies ahead.
  6. The distance of valuations from earnings is directly proportional to the degree of bubbliness.
  7. The newer the valuation methodology in vogue the greater the degree of bubbliness.
  8. Bad valuation methodologies drive out good valuation methodologies.
  9. When everyone thinks central bankers, money managers, corporate managers, politicians or any other group are the smartest guys in the room, you are in a bubble.
  10. Rapid growth of a new financial product that is not understood. (e.g., derivatives, what Warren Buffett termed “financial weapons of mass destruction”).

While some of the above conditions/laws have been met today, many have not.

While debt is cheap and plentiful to some, it is not universally so, as lending standards (especially mortgages and small-business loans) are relatively tight.

2 thoughts on “Identifying the Bubble

  1. The Indian market growth picked up in a big way after US stimulus resulted in relatively large FII flows ….FIIs were obviously looking for greener pastures and India story seemed to be appealing to them to commit a decent and increasing part of their portfolio. Since Indian market lacks depth and there are limited stocks which may meet global liquidity and maket cap standards, this lead to a spurt in Sensex/Nifty. For some time, markets were at “unreasonably high” levels.
    In the intervening period (2012 and 2013) , the story seemed to be losing steam due to policy paralysis on domestic front and withdrawal of QE on global front. This was a blessing in disguise as this allowed for consolidation and earnings could do some catching up whereby fundamentals remained closer to the reality (reasonable PEs etc).Thus bubble was avoided.
    Now ECB has announced the QE which has the bulls excited. No doubt they will take the markets again to the “unreasonable” levels (33,000,35,000 ??).
    It can cause a bubble if the leves move from “nreasonable” to “unsustainable” which will happen if they move way beyond the earnings ( move high in a very short period).Earnings too can catch up IF there are reforms…
    Another danger is global slowdown. 2009 showed us that we are not all that de-coupled……

    Barring these scenarios, I don’t see a bubble …..if growth is steady even though slightly ahead of fundamentals as markets always discount the future (should not discount the too distant future,,,,as it is always hazy beyond the horizon).


    1. I am not a political person or anti Modi , but here are the few things that could be reason for the bubble : ITC, L&T and Axis bank – three companies which are run for the top shareholders and top management have ensured that the government owns the stake and the ‘top’ management can do what it wants. Enjoy guys. Has done NOTHING in changing the ownership patterns of the companies that they have partly privatised. Continues to interfere in ‘free’ pricing of petrol. Continues to subsidise Air India and allows loot on the other side. India’s biggest paradox in management. Interferes in banks- allowing the accumulated losses of Spice Jet, etc. to mount Public sector banks can still do what they want, and Gyan sammelans do not bring about anything new. The massive account opening tamasha happened far more in psu banks than in private sector banks. Coal India! Jaitely decides on E auction? privatisation of energy sector? MY left foot, Mr. Modi. On the economic front nothing has really changed. Am I happy or sad? Neither. I prefer a man who says one thing and does the same thing. That is all. Forked tongue is what Firstpost called him in an article. I would like to remind you of ‘Ravana’ – 10 tonuges – forked is just 2 right? –


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