Question:
What are the signs of a market bubble? I hear market pundits yammering about the next big bubble and while I’m not trying to time the market, I don’t want my small-cap holdings swept up in a big burst.
Answer:
At Henssler Financial, we believe the key sign of a market bubble is when investors are coming up with different rationales or metrics to value a stock. For example, if earnings are not good, investors will look to obscure metrics like potential cash flow, number of users or potential price-to-earnings in 2025. If a company does not have earnings, it is of no value to us. One of the biggest bubbles we see is Amazon.com (NASDAQ: AMZN) because the company is able to keep increasing its sales; however, it is not making any money.
Companies most prone to bubbles are those with rapid sales growth. While a new company may reinvest revenues into company growth, eventually that has to stop and the company has to make money. During bubbles, low quality companies will often have large P/E ratios.
Bubbles also happen when the market is priced irrationally. In 2000, the entire market was trading at 30 times earnings. The Technology sector was trading nearly 73 times earnings, while some individual stocks in Technology were trading at 100 times earnings. The current market P/E is 16.5, which is in line with the long-term average. When a market starts trading at 30 times earnings, it is time to be concerned.
There is also a difference between being overvalued and a bubble. The stock market will always go up and down. It’s no secret stocks are more expensive today than they were a year ago. However, investors still need to invest money today. An investor needs to compare the relative valuation of stocks to other assets. The market may not be cheap, but it may be the best place to be long term. A 10-year U.S. Treasury yields 2.49%. You can get a high-quality stock that pays more than that in dividends and has the potential to increase in value.
We think the current market is fairly priced. At Henssler Financial we believe you should Live Ready, and that includes understanding the signs in the market. If you have questions regarding your investments, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
