Spotting Bubbles in Practice

Can you identify a bubble before it bursts? Several warning signs help: price-to-earnings ratios far above historical averages, widespread use of leverage to buy assets, and a narrative that "this time is different" from all previous bubbles.

New participants flooding in — taxi drivers giving stock tips, first-time buyers stretching beyond their means — signals late-stage euphoria. When the justification shifts from fundamentals to "prices will keep going up," the bubble is likely near its peak.

Yet identifying bubbles in real time remains notoriously difficult. As the old market adage goes, markets can stay irrational longer than you can stay solvent. Being right too early is financially identical to being wrong.