The truth behind market 'bubbles'

The term “bubble” is one of the most overused and abused investment terms. At least that’s what Paul Schatz, President of Heritage Capital, told Yahoo Finance. “Ever since the dot-com bubble burst, anytime an asset class, or a stock or a sector really appreciates the pundits all slap the word bubble on it,” Schatz says.

While he of course admits that bubbles are a real thing, many market moves that the media slaps with the moniker are just investor fear. “Bubbles are made up of psychology,” Schatz argues. “It’s greed, greed drives bubbles. Fear is not a bubble. So just because stocks appreciate doesn’t mean they’re in a bubble and not every bear market is gonna begin because the stock market is in a bubble.”

So how can you tell the difference between a real bubble and one manufactured by pundits? Schatz says the real answer is probably something along the lines of “I’ll know it when I see it,” but there are some signs that, at the very least, should serve as a warning sign that a bubble may be nigh.

“Do you see it in the paper? Not in the investing section but the front page of the USA Today. Are people clamoring for it?”

In other words, when those who are not usually part of the investing conversation salivate at the thought of a particular stock or sector, it might be time to take a closer look at what is causing that hysteria.

The most well-known example, suggests Schatz, is the dot-com bubble of the late 90’s and early 2000’s. Everyone and their brother was trying to get into these hot stocks and the prices were driven sky high. It illustrates a second tell-tale sign of a potential bubble too.

Once the “b-word” makes it into the conversation the stock or sector usually surges again before the bubble pops. Schatz notes that dot-coms grew by about 100% after the bubble talk began and before the eventual downfall.

Looking for a more recent example? Apple, says Schatz, was definitely in a bubble a few years ago when everyone was trying to get in on the stock. The share price was tracked by those who otherwise wouldn’t care and eventually the stock fell from grace.

On the other hand, he says, “to talk about Alibaba being in a bubble or social media, I don’t see the public clamoring for these stocks.”

In fact, Schatz says he doesn’t see anything in the markets now that looks like a bubble at all. “Now if the Dow melted up 50% over the next six to eight months, then I’d say many of those stocks may be in a bubble [but]...the individual investor is not running into stocks right now.”

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