In his recent article titled – Are We In A Stock Market Bubble, Ray Dalio discusses the six measures of his systemized “bubble indicator” which gives him perspective on the market at any time. Here’s an excerpt from the article:
I’ve seen a lot of bubbles in my time and I have studied even more in history, so I know what I mean by a bubble and I systemized it into a “bubble indicator” that I monitor to help give me perspective on each market. We now use it to look at most markets we are in. I want to show you how it works and what it is now showing for US stocks.
What I mean by a bubble is an unsustainably high price, and how I measure it is with the following six measures.
- How high are prices relative to traditional measures?
- Are prices discounting unsustainable conditions?
- How many new buyers (i.e., those who weren’t previously in the market) have entered the market?
- How broadly bullish is sentiment?
- Are purchases being financed by high leverage?
- Have buyers made exceptionally extended forward purchases (e.g., built inventory, contracted forward purchases, etc.) to speculate or protect themselves against future price gains?
Each of these six influences is measured using a number of stats that are combined into gauges. In the stock market we do it for each stock that we are looking at. These gauges are combined into aggregate indices by security and then for the market as a whole. The table below shows the current readings of each of these gauges for the US equity market as a whole, and the chart below it shows the aggregate reading derived by combining these gauges into one reading for the stock market going back to 1910. It shows how the conditions stack up today for US equities in relation to past times.
In brief, the aggregate bubble gauge is around the 77th percentile today for the US stock market overall. In the bubble of 2000 and the bubble of 1929 this aggregate gauge had a 100th percentile read.
You can read the entire article here:
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