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If you look at Zoom Video Communications Inc. (NASDAQ: ZM) and Shopify Inc. (NYSE: SHOP), you might think we're in a bubble. These stay-at-home stocks make it look like 1999 all over again.
ZM is up 494% year to date. SHOP is up 179%. And the S&P 500 keeps chugging along with a 65% return since the COVID-19 crash in March.
Let's see if there's anything to this stock market bubble thing...
The ratio that Warren Buffett once called a good measure of value, market cap to GDP, points to a bubble. At 1.6, this ratio is actually slightly higher than the 1.59 hit during the dot-com bubble and way over the 1.16 mark hit in 2007, right before the Great Financial Crisis.
The IPO market also makes a strong case for a bubble. Nineteen IPOs have doubled in value this year. The average offering has risen by more than 30% on the first day of trading.
That is very bubble-like.
Stocks have been rising even though many areas of the economy are in horrible condition. Roughly 18 million people are collecting some sort of unemployment benefits right now.
Hundreds of thousands of small businesses have had to close.
We are seeing an accelerated spread of coronavirus, and more states may go back on lockdown.
In spite of the weakness, the stock market just keeps going higher.
Should we get out while the getting is good?
The truth is that we probably should not. Bubbles rarely happen when everyone is talking about market bubbles.
Consider This Before Selling Stock
This market has been fueled by low interest rates and the hopes of a vaccine.
Rates are not going to go higher anytime soon. The Fed has suggested that it will be well into 2023 before it is ready to even think about raising rates.
The second drug will be approved later this week.
We will begin to see the economy open back up in the second half of the year, and traders are very bullish about the next three to six months in the stock market.
Although technology stocks have led the way higher, and many of them do look pricey to us, some sectors are still priced at attractive levels. These stocks could see an enormous boost as the vaccine becomes widely available.
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Banks and other financial stocks have not rallied heavily as yet. Many banks are still priced at a very low price to earnings and trade well below pre-pandemic levels.
Many real estate investment trusts are still well below the prices they were trading at before the pandemic arrived.
In a bubble, almost all stocks are overpriced.
Today, some stocks appear to be overpriced.
Many others are fairly valued, and others are bargains.
The vaccine should get the economy moving in the right direction for almost all sectors.
In addition to the vaccine, 2021 will give us new advances in some world-changing technologies like 5G, electric vehicles, and the Internet of things. The e-commerce boom will also continue.
The Biden administration will pivot toward major green energy projects, which will create some good, high-paying jobs.
How to Play a Potential Market Bubble
Some parts of the market look expensive right now. If you own some of the high-flying names, this might be a good time to start paring back your holdings a bit.
I do not think that exiting the market in a wholesale fashion would end up being wise.
If memories of what happened back in March keep you awake at night - at the possibility of this being a bubble that suffers a horrific crash - there are a few steps you can take to sell better.
First, you can always go to the options market and buy insurance against a crash. Right now, it will cost you about 3% to protect yourself against a loss of greater than 20% in the broader market between now and mid-March.
You will need to buy one options contract for every $36,000 of market value you are trying to protect.
You can also sell call options against your highly appreciated holdings. This will bring in some cash that can at least partially offset any losses from a market decline.
You can also set a trailing stop. Decide your pain point on the stocks you own and place an order to sell if prices get to that level.
If the stock continues to move higher, reset your stop order.
Bubbles are usually discovered in hindsight. When the press is full of headlines about the possibility of a crash and bubbles popping, there is a reasonable chance prices will keep working higher until the last few market bears throw in the towel.
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