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The surge in stock market indexes after the election has investors wondering if there is a stock market bubble forming.
The Dow closed at a record high on Tuesday, Nov. 15, its fourth day in a row of a record-breaking close. The Nasdaq and S&P 500 have both risen 2% since the election. SPDR S&P 500 ETF Trust (NYSE: SPY) has seen a record inflow of $14 billion since the election.
Indicators already show the stock market is overinflated, and with stocks hitting record highs since the election, a stock market bubble is now a serious possibility. When bubbles are popped, the market crashes.
We'll show you how to protect your money if the stock market bubble bursts. But first, we'll show you what a stock market bubble is and why we're in one now…
What Is a Stock Market Bubble?
A stock market bubble occurs when buyers drive up the price of stocks far above what they are really worth.
A bubble is the product of an investor feeding frenzy. As stocks rise, more investors want in on the gains. When investor zeal pushes stocks above their real value across the entire market, a stock market bubble is formed.
But stock prices inflated like this are not sustainable. This is why bubbles eventually pop and the entire market crashes.
The big question about financial bubbles is how to know when the market is in one. Thankfully, history can tell us a lot. We'll look at what led to past financial bubbles to show you why we are in one today…
Our Stock Market Bubble History
One of the earliest economic bubbles occurred in 17th century Holland over the price of tulips.
The popularity of Dutch tulips exploded alongside the growing use of a tulip as a symbol of status. As prices increased, growers paid more and more money for tulip bulbs. Futures contracts were traded as speculators who never planned to grow the flower sought to benefit from rising prices. This further pushed up the price.
"Tulip Mania" came to a crashing end in 1637 when prices dropped. Panicked investors began selling their contracts hoping to save some of their investment money. Prices plunged as buyers underbid desperate sellers.
More recently, the dot-com bubble of the 1990s saw investors make a very similar mistake. As the internet began to take off in the 1990s, tech companies were expected to see explosive growth as a result. Investors swarmed tech stocks, driving up their prices to exorbitant levels.
Between 1995 and 2000, the technology-dominated Nasdaq jumped from under 1,000 to more than 5,000. Speculation drove much of the rise, as investors bought up any stock associated with the internet, expecting the boom would continue.
The most famous of these was Pets.com. The pet supply site never made a profit and lost $300 million of investor capital when the market bubble burst. Pets.com debuted on the market in 2000 at $11 a share and ended the year at $0.19 a share after the bubble burst.
By the end of 2001, many overvalued dot-com companies had folded, causing trillions of dollars in investment capital to disappear overnight.
We are currently seeing signs of the sort of speculation that led to these past stock market bubbles…
Is There a Stock Market Bubble?
Investors have been enjoying a seven-year bull market, and stock prices have driven indexes to record peaks this year. But evidence shows this is the result of speculation.
One of the main reasons stocks are continuing to rise is because the United States, and many other countries, are in a period of historically low interest rates. Because of low interest rates, bonds are an unprofitable investment, so investors have turned to buying stocks to get a better return. The influx of stock buyers has driven share prices up.
Another issue contributing to a stock market bubble is a lack of economic growth to support soaring stock prices.
Corporate growth is not helping grow the stock market. FactSet reports that corporate earnings are down for the sixth straight quarter, yet the Dow is breaking record highs. This is a sign of speculation.
And the bubble can pop at any moment. If the Fed raises interest rates, investors could pull out of the stock market and trigger a stock market crash.
But smart investors will be prepared. Here is our stock market protection plan that will protect your money, and even help you profit, if the market crashes…
Stock Market Crash Protection Guide
Stocks are the riskiest asset to have during a stock market crash. That's why Money Morning Global Credit Strategist Michael Lewitt recommends investors keep up to 20% of their portfolio in gold.
Gold is a source of stability during periods of market uncertainty and can help balance your portfolio.
Buying and storing physical gold is a popular way of investing in the metal, but it's not for everyone due to security concerns. Another gold investment option is a gold ETF. Lewitt recommends the SPDR Gold Trust ETF (NYSE Arca: GLD). GLD is trading at $116.84 and is up 15% year to date (YTD).
Another option for investing in gold is to buy stock in major mining companies. Due to the stability of gold during crises, owning stock in a gold mining company can balance against a volatile market. An excellent choice is Goldcorp Inc. (NYSE: GG). This well-run Canadian mining company has shares trading at $13.71, with gains of 18.77% YTD.
A profitable play during a stock market crash is to short the market. A reverse ETF allows you to short an entire index. When the overall market falls, your share price rises.
ProShares Short S&P 500 ETF (NYSE Arca: SH) shorts the S&P 500 Index. This will prove profitable if the S&P 500 crashes. SH is currently trading at $37.68 and is down 9.6% YTD, because the S&P 500 is up 6.51% on the year. This means buying SH must be timed right and isn't an ETF to buy and hold, but purchasing SH before the market crashes will lead to profits.
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