Identifying Signs of Stock Market Bubble

The U.S. stock market has recently reached yet another record high. But is this surge supported by strong underlying fundamentals, or is it quietly inflating into a bubble? In this article, we introduce one key indicator that can help you spot the early signs of market overheating and safeguard your portfolio against potential bubbles.

Key Indicator: FINRA Margin Balance Divided by Currency in Circulation

This indicator can be used to assess willingness to borrow for investments. Elevated margin debt levels suggest retail investors are flooding in, which means a bubble might be forming quietly and the likelihood of overvaluation in the stock market is increasing. Subsequent and sharp declines from the heightened levels would signal the burst of the bubble. (To put it simply, the red flag for a bubble is margin debt shooting up, as it can be an indication of the shoe-shine boy effect.)

Takeaway

Reflecting on historical precedents, notably the dot-com bubble of the early 2000s and the global financial crisis in 2008, both indicators consistently signaled the need to exit.

Coming back to the present, while stock valuations are soaring, it's noteworthy that margin debt financing has remained relatively low, indicating lingering cautious sentiment among retail investors and a low likelihood of an imminent bubble. It’d be wise to continue to closely monitor FINRA margin balance divided by currency in circulation. If exuberance prevails and retail investors begin to flood the market, the signal of a burgeoning bubble can be found in this indicator, where a reversal from peak levels warrants extra caution, as it would indicate heightened risk of an impending correction.

What is your target price for the S&P 500 by the end of 2025?

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