Are We in a Stock Market Bubble Now?

stock market bubbleStocks have been on a record-breaking tear this year, but after seven-and-a-half years of growth, many wonder if we are in a stock market bubble.

The three major indexes each smashed their all-time records this week (Tuesday, Dec. 13). The Dow is within striking distance of the 20,000 mark, less than a month after soaring above 19,000. On Dec. 1, all five major stock indexes in the United States closed at record highs. A feat that last happened 18 years ago in 1998.

These record-breaking gains in stock markets are making investors money. But these soaring numbers could be a sign of a stock market bubble.

If we are in a stock market bubble, then a stock market crash might not be too far away...

That's why we want to help investors prepare for a market correction. Before we do, this is how to identify a stock market bubble and why it's important to know...

What Is a Stock Market Bubble?

A market bubble refers to an unsustainable rise in prices. Stock market bubbles are inflated through speculation, driving prices to artificially high levels. When prices get too high, the bubble pops and the stock market could crash...

This has happened several times throughout history.

The most catastrophic of these was the 1929 stock market crash. Stock prices soared to unimaginable levels during the Roaring '20s. Investors were certain that stocks could only rise and invested recklessly to ensure they wouldn't miss out on the profits.

Many investors even borrowed money to buy stocks. By the end of the decade, nearly $125 billion, adjusted for inflation, was invested on margin.

But nothing is sure in the stock market.

Speculation was fueling the record performance of stocks in the 1920s. That meant the highs couldn't last. When the stock market went down in 1929, margin buyers were forced to sell. Other buyers sold, hoping to get back at least some of their money. As buyers sold, prices plunged.

When the dust cleared, it had lost more than 86% of its value before the recovery began in 1932.

More recently, the stock market crash of 2008 led to more than $2 trillion in retirement savings getting wiped out.

This time, a bubble in the housing market drove stock prices to unsustainable levels.

A steady period of rising housing prices caused many to believe the housing market was a safe bet. Money poured into housing. Buyers were taking out loans they couldn't afford, expecting rising prices to bail them out.

But the bubble eventually burst.

Eventually, housing prices flattened. Many could no longer afford mortgage payments and were forced to sell. A surge of sellers drove prices down. Many people defaulted, and soon banking stocks were crashing.

The bursting of the housing bubble led to a stock market crash.

Today, we're seeing similar signs of speculation fueling record highs on the stock market. Investors need to be aware stocks won't always rise. Here's how higher interest rates could send stocks tumbling...

Will the Fed Rate Hike Cause a Stock Market Crash?

Between 2007 and 2008, the Fed slashed rates from over 5% to 0.25%. The Fed has kept rates below 1% since 2008. While historically low interest rates have fueled stock market gains since then, that's coming to an end...

The Fed cut rates in an effort to stimulate the economy after the 2008 financial crisis.

The idea was lower interest rates would make borrowing money cheaper. Cheaper borrowing would mean companies would be more willing to expand. And expanding companies would grow the economy.

The problem is lower interest rates helped fuel the stock market instead of the overall economy.

With interest rates at such low levels, bond investors had no choice but to turn to stocks. The money going into stocks helped drive up prices.

Companies also took advantage of the cheap borrowing rates. But they used them to repurchase their own stock shares. Companies have bought over $2 trillion of their own shares since 2008, while borrowing more than $1.9 trillion during the same time.
The diminished value of bond investment and the share buybacks have likely pushed stock market averages above where they would be otherwise.

Now the low interest rates that encouraged stock buying are on their way out.

Don't Miss: How to Make a Killing... When Everyone Else Is Panicking

On Dec. 14, the Fed announced it is raising interest rates another 0.25%. That means loans cost more and bonds pay a better rate of return.

The Fed also indicated it plans to raise rates three more times in 2017. That has us prepared for a stock market crash in 2017.

No one can say for certain what the market reaction will be. But higher interest rates could pull money out of stocks and prices could fall back to earth. That's why investors should always be prepared. Here's how to protect your money from a stock market crash....

How to Protect Your Money from a Stock Market Crash

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Money Morning Chief Investment Strategist Keith Fitz-Gerald takes the long view on preparing for market corrections. Fitz-Gerald says investors shouldn't flee stocks, but should invest in strong companies in "Unstoppable Trends."

Fitz-Gerald's "Unstoppable Trends" are demographics, energy, technology, health, scarcity, and war. Because the trends exist regardless of market moves or political changes, the companies in these industries are always in demand.

Here are three well-managed companies in our "Unstoppable Trends."

Microsoft Corp. (Nasdaq: MSFT) has a business model predicated on the constant need for technology. Its products are used on computers all over the world. Day in and day out, computer users use MSFT products. Microsoft's products will always be in demand, and they are one of the top companies in the world at supplying them.
Defense contractor Raytheon Co. (NYSE: RTN) has billion-dollar Department of Defense contracts for both cybersecurity and conventional defense. Because the United States will always need to be secure, Raytheon is a strong long-term play, even if the market dives.

Becton Dickinson and Co. (NYSE: BDX) makes medical supplies and lab equipment. That means it's positioned to benefit from demographic changes, like an aging population. Aging people have chronic conditions and need a steady supply of treatments. BDX is a top supplier.

While these stocks will help in the long term, investors also need short-term security.

Michael Lewitt, Money Morning's Global Credit Strategist, believes investors should have 10% to 20% of their portfolio in gold. Gold is a safe-haven investment and will hold its value during market downturns.

We think a low-fee ETF like iShares Gold Trust (NYSE Arca: IAU) is a great way to get all of the benefits of gold without having to physically buy it. IAU mirrors the performance of gold, yet trades on the exchanges like a stock.

Finally, if a stock market bubble causes markets to plummet, protect yourself by buying shares that trade in the opposite direction of the S&P 500. Money Morning Capital Wave Strategist Shah Gilani notes that ProShares Short S&P 500 (NYSE Arca: SH) is a good investment to buy right before a crash. When the S&P 500 goes down, SH will rise.

By the same token, though, be sure to note that holding it could wipe out your gains. It is not recommended for long-term purchase.

Act Now: An incredibly rare gold market anomaly is shaping up in the markets as we speak -- one that has occurred ONLY twice in the past 20 years. And it's about to happen again. Details here...

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