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\t\t\tIs there a stock market bubble? Here are the warning signs<\/p>\n \t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\tIs there a stock market bubble? Here are the warning signs<\/p>\n
During a boom,\u00a0warnings of bubbles and crashes\u00a0are swept under a rug woven with proclamations such as \u201cwe\u2019ve entered a multi-year bull market\u201d and \u201cthere\u2019s so much money on the sidelines waiting to invest\u201d.<\/p>\n
This\u00a0article<\/a>\u00a0was first published in The Australian on 06 October 2025.<\/p>\n As an aside, that latter statement reveals an oversight: when cash on the sidelines is used to buy stocks, it is given to vendors who swap shares for cash on the sidelines. There must always be cash on the sidelines.<\/p>\n Another red flag was raised recently when Bank of America\u2019s Savita Subramanian wrote to clients observing that attributes inherent\u00a0in the current mix of leading stocks\u00a0include less financial leverage, lower earnings volatility, increased efficiency and more stable margins than in decades past help to support the towering valuations.<\/p>\n \u201cPerhaps we should anchor to today\u2019s multiples as the new normal rather than expecting mean reversion to a bygone era,\u201d Subramanian says.<\/p>\n Subramanian\u2019s words are reminiscent of those uttered by Yale economist Irving Fisher during another roaring stock market, in a speech to the Purchasing Agents Association on October 15, 1929, in New York City. As reported by The New York Times the next day, Fisher said: \u201cStock prices have reached what looks like a permanently high plateau.\u201d<\/p>\n He added: \u201cI do not feel that there will soon, if ever, be a 50- or 60-point break below present levels.\u201d And, in reply to one question following his speech, he added that he expected \u201cto see the stock market a good deal higher than it is today, within a few months\u201d.<\/p>\n Fisher\u2019s comments are remembered as the most notoriously inaccurate market forecast in history. By November 11, 1929, the index had plunged 40 per cent from its September high. The Dow Jones then lost just shy of 90 per cent before finally bottoming out in July 1932.<\/p>\n Bubble definitions abound, but most fall into two camps:\u00a0those that measure overvaluation\u00a0and those that observe the behaviours and conditions that typically give rise to it. The trouble, however, is that\u00a0a bubble is only ever definitively confirmed once it has burst. That\u2019s why understanding the different types of past bubbles is helpful now.<\/p>\n They\u2019re all winners\u00a0<\/p>\n I believe one type of bubble emerges when every company in a sector is priced like a winner. That\u2019s when investors have disengaged from the reality of competitive capitalism. That\u2019s when all the laggards have caught up to the leaders, and the forecast of each company\u2019s earnings, when aggregated, is so unrealistic it cannot possibly be achieved.<\/p>\n The most straightforward definition of a bubble is asset prices climbing far above some measure of value, such as earnings, dividends, gross-value-added or discounted cashflows.<\/p>\n Robert Shiller\u2019s famous CAPE ratio, which compares stock prices to long-term average earnings, and John Hussman\u2019s market cap to GVA (gross value-added) were designed to flag these distortions.<\/p>\n The\u00a0dotcom era\u00a0is a textbook case of this definition. That was when internet stocks with no profits and little revenue traded at astronomical multiples. Valuations hit hundreds of times forward sales, but promised earnings never materialised.<\/p>\n Hyman Minsky and Charles Kindleberger proposed bubbles are less about a static mis-pricing and more about a dynamic process. They described a five-stage arc: displacement, boom, euphoria, profit-taking, and, ultimately, panic.<\/p>\n Then there\u2019s the \u201cgreater fool theory\u201d. That\u2019s when value doesn\u2019t matter if there\u2019s always a buyer lined up at a higher price. It\u2019s my favourite bubble definition, and it comes from John Kenneth Galbraith in The Great Crash. \u201cAt some point in a boom, all aspects of property ownership become irrelevant except the prospect for an early rise in price. Income from the property, or enjoyment of its use, or even its long run worth is now academic \u2026 what is important is that tomorrow or next week, market values will rise, as they did yesterday or last week, and a profit can be realised.\u201d<\/p>\n Tulip mania in 17th-century Holland, where rare bulbs reportedly traded hands for the price of a house, embodies this idea. Buyers then weren\u2019t after flowers; they were betting on resale.<\/p>\n Another perspective suggests bubbles are the by-product of excess liquidity. When central banks flood markets with cheap money or when capital flows surge, asset prices can detach from underlying fundamentals. Liquidity, not valuation, is the true fuel of bubbles. During the U.S. housing boom of the 2000s, ultra-low interest rates following the dotcom crash, and lax lending standards, generated a torrent of credit into real estate. But liquidity tightened, defaults spiked, and we had the Global Financial Crisis (GFC).<\/p>\n Former U.S. Federal Reserve chair Alan Greenspan\u2019s \u201cirrational exuberance\u201d framed bubbles as collective psychological episodes: herd overconfidence that overpowers rational analysis.<\/p>\n At the peak of Japan\u2019s late-1980s bubble, land in Tokyo was worth more than all U.S. real estate. The Nikkei\u00a0traded at more than 60 times earnings, driven not by profits but by conviction that Japan\u2019s rise was inexorable.<\/p>\n A bubble is clearest in hindsight. Fortunately, through the lenses of past bubbles, we can ask ourselves whether today\u2019s prices are worrisome.<\/p>\n We have estimates of fair value exceeded; we have euphoria; and we have examples of the greater fool theory \u2013 see stocks such as Robinhood, Polymarket, and Plasma.<\/p>\n We also have record global liquidity, and we have plenty of irrational exuberance, because the economy can\u2019t produce the revenues artificial intelligence (AI) companies will need to recoup their massive infrastructure investments.<\/p>\n If time tells whether we are in a bubble, history may already have.<\/p>\n This\u00a0article<\/a>\u00a0was first published in The Australian on 06 October 2025.<\/p>\n MORE BY Roger<\/a>INVEST WITH MONTGOMERY<\/a> Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.<\/p>\n He is also author of best-selling investment guide-book for the stock market, Value.able<\/a> \u2013 how to value the best stocks and buy them for less than they are worth.<\/p>\n
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