Studies of Life

Learning by doing.

How do you know stocks are in a bubble?

05 December 2015 by Jim

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:

Current valuations

 

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.

5 comments | Categories: Investing | Tags: , , , , ,

Comments (5)

  1. Well, it’s pretty cool that you used my comment to write a new post as an answer 🙂 thank you 🙂 As always, I have a question for you. How many years you invest yet? When you started investing?

  2. “Investing in P2P lending can improve diversification significantly because the returns of P2P lending should be uncorrelated with the stock and bond markets.”

    Except of course your experience with P2P lending has been in the aftermath of the recent stock boom. When there is a market crash (comparable to 2007/8), it also means people are losing jobs and in general making less money so they are unable to pay back their loans. I think this will have an effect on P2P lending as well and it is still to new a thing to know what effect…

    What do you think?

    • You are right that nothing is 100% uncorrelated. And a stock market crash can have an effect on people paying back their loans. BUT I do not think that, if the stock market loses 60%, that 60% of the loans will go bad. First, most people in need of P2P loans are not people with a lot of money who lose a lot in the stock market. Second, many of the loans I now invest in are asset-backed, so if the borrowers default, the loan value is at last partly insured. So I still think that P2P investments are an *relatively* uncorrelated asset class to add to a stock portfolio.

      • Of course they are not invested in the stock market, but the companies that crash and have to restructure will first lay off the common workers, exactly the people who don’t have money invested and who need these kinds of loans the most.

        I know, I am sounding pretty pessimistic in these comments. I do want to give it a shot myself though. Do you have any articles written about the tax implications that come from P2P lending – I still need to check how that works (in Belgium)?

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