How do you know stocks are in a bubble?
A reader, Algirdas, recently left several questions below a post, and I thought the answers might interest most of you, so I decided to answer with another post.
> You said: “Right now, stocks and bonds are pretty expensive. It’s not a good idea to invest all of your money into either category right now, because there could be a big decline soon” How to know when stock market reached the bubble or had a big decline? Maybe you can share a source where you can look the current stock market situation considering the whole stock market performance history? How do you know when stocks are expensive? Or in a bubble?
A ‘bubble’ means that stocks would be about to burst because they are too expensive, i.e. their valuation is no longer reasonable. It is difficult to be sure that stocks are in a bubble – except in hindsight.
But it is quite easy to see when stocks are expensive or cheap. If you look at the excellent site of StarCapital, you can see current valuations of different national stock markets. Here’s what that looks like as of the date of this post:
So you can see that the US looks expensive, and Germany, Japan and France do too, but Brazil and Russia are cheap, and China and Australia are rather cheap as well. For this reason, I recently bought a small position in a Russia ETF, and a small one in a China ETF. I don’t know enough about these markets to pick stocks in them, but I feel reasonably confident that both China and Russia have potential.
> Do you invest in real estate or supplies (Gold silver) also? I ask you this, because, if the stock market is having a decline, no matter what stocks you have, all stocks goes down by its value. Many people say, diversify your portfolio by a lot of stocks, or by ETF (where are a lot of stocks and bonds) but the truth is, all stocks goes down if there is market crisis.( Like 2003 or 2008) Diversifying is just an illusion because you diversify your portfolio in the same asset just different stocks. Are you agree with that?
Diversification in stocks and bonds is important. And investing in real estate and commodities like gold also improves diversification. But there’s no guarantee that any of these will keep its value when there is a crash. They can all decline in value. Investing in P2P lending can improve diversification significantly because the returns of P2P lending should be uncorrelated with the stock and bond markets.
> and what is you exiting strategy? Or you don’t have one? You sell stocks on the market bubble and hold money safely at the bank or you invest your money somewhere else? In gold, silver etc? It’s very interesting for me. I read a lot of books during few months and realised that investing for long in stock market is very bad advice, because there are market cycles, and if you are 75 years old man and you have etc. 2 mln dollars in stock market and suddenly the market crashed you don’t have time to wait when market will start rising again and there you’ve lost a lot of money.
I do not have an exit strategy. Right now I plan to continue putting my income into different investment opportunities, including stocks, bonds, P2P lending and (at some point in the future) into real estate. I also have some money in a bank account which is not invested. As I get older (I’m now 24) I will increase the amount of money in that safe bank account, to make sure I don’t suffer a major loss when I’m 75 as you say. But a substantial amount will remain invested. There is no way to guard against losses. And if you could get out of the market before you loose a lot, you wouldn’t know when to get back in again. So just don’t try timing the market. Just continue investing, but diversify sufficiently.
That’s all there is to it!
In investing and in life, there is no guarantee that it will work out in the end. I might be struck by a car tomorrow and die. And I might at 75 suffer a major loss due to a market crash. I still think investing a lot is the smartest choice a person can make right now.