Is there a stock market bubble? Here are the warning signs
During a boom, warnings of bubbles and crashes are swept under a rug woven with proclamations such as “we’ve entered a multi-year bull market” and “there’s so much money on the sidelines waiting to invest”.
This article was first published in The Australian on 06 October 2025.
As an aside, that latter statement reveals an oversight: when cash on the sidelines is used to buy stocks, it is given to vendors who swap shares for cash on the sidelines. There must always be cash on the sidelines.
Another red flag was raised recently when Bank of America’s Savita Subramanian wrote to clients observing that attributes inherent in the current mix of leading stocks include less financial leverage, lower earnings volatility, increased efficiency and more stable margins than in decades past help to support the towering valuations.
“Perhaps we should anchor to today’s multiples as the new normal rather than expecting mean reversion to a bygone era,” Subramanian says.
Subramanian’s words are reminiscent of those uttered by Yale economist Irving Fisher during another roaring stock market, in a speech to the Purchasing Agents Association on October 15, 1929, in New York City. As reported by The New York Times the next day, Fisher said: “Stock prices have reached what looks like a permanently high plateau.”
He added: “I do not feel that there will soon, if ever, be a 50- or 60-point break below present levels.” And, in reply to one question following his speech, he added that he expected “to see the stock market a good deal higher than it is today, within a few months”.
Fisher’s comments are remembered as the most notoriously inaccurate market forecast in history. By November 11, 1929, the index had plunged 40 per cent from its September high. The Dow Jones then lost just shy of 90 per cent before finally bottoming out in July 1932.
Bubble definitions abound, but most fall into two camps: those that measure overvaluation and those that observe the behaviours and conditions that typically give rise to it. The trouble, however, is that a bubble is only ever definitively confirmed once it has burst. That’s why understanding the different types of past bubbles is helpful now.
They’re all winners
I believe one type of bubble emerges when every company in a sector is priced like a winner. That’s when investors have disengaged from the reality of competitive capitalism. That’s when all the laggards have caught up to the leaders, and the forecast of each company’s earnings, when aggregated, is so unrealistic it cannot possibly be achieved.
The most straightforward definition of a bubble is asset prices climbing far above some measure of value, such as earnings, dividends, gross-value-added or discounted cashflows.
Robert Shiller’s famous CAPE ratio, which compares stock prices to long-term average earnings, and John Hussman’s market cap to GVA (gross value-added) were designed to flag these distortions.
The dotcom era is a textbook case of this definition. That was when internet stocks with no profits and little revenue traded at astronomical multiples. Valuations hit hundreds of times forward sales, but promised earnings never materialised.
Hyman Minsky and Charles Kindleberger proposed bubbles are less about a static mis-pricing and more about a dynamic process. They described a five-stage arc: displacement, boom, euphoria, profit-taking, and, ultimately, panic.
Then there’s the “greater fool theory”. That’s when value doesn’t matter if there’s always a buyer lined up at a higher price. It’s my favourite bubble definition, and it comes from John Kenneth Galbraith in The Great Crash. “At some point in a boom, all aspects of property ownership become irrelevant except the prospect for an early rise in price. Income from the property, or enjoyment of its use, or even its long run worth is now academic … what is important is that tomorrow or next week, market values will rise, as they did yesterday or last week, and a profit can be realised.”
Tulip mania in 17th-century Holland, where rare bulbs reportedly traded hands for the price of a house, embodies this idea. Buyers then weren’t after flowers; they were betting on resale.
Another perspective suggests bubbles are the by-product of excess liquidity. When central banks flood markets with cheap money or when capital flows surge, asset prices can detach from underlying fundamentals. Liquidity, not valuation, is the true fuel of bubbles. During the U.S. housing boom of the 2000s, ultra-low interest rates following the dotcom crash, and lax lending standards, generated a torrent of credit into real estate. But liquidity tightened, defaults spiked, and we had the Global Financial Crisis (GFC).
Former U.S. Federal Reserve chair Alan Greenspan’s “irrational exuberance” framed bubbles as collective psychological episodes: herd overconfidence that overpowers rational analysis.
At the peak of Japan’s late-1980s bubble, land in Tokyo was worth more than all U.S. real estate. The Nikkei traded at more than 60 times earnings, driven not by profits but by conviction that Japan’s rise was inexorable.
A bubble is clearest in hindsight. Fortunately, through the lenses of past bubbles, we can ask ourselves whether today’s prices are worrisome.
We have estimates of fair value exceeded; we have euphoria; and we have examples of the greater fool theory – see stocks such as Robinhood, Polymarket, and Plasma.
We also have record global liquidity, and we have plenty of irrational exuberance, because the economy can’t produce the revenues artificial intelligence (AI) companies will need to recoup their massive infrastructure investments.
If time tells whether we are in a bubble, history may already have.
This article was first published in The Australian on 06 October 2025.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
By now, every investor has heard the bubble warning. Yet, when markets are soaring on optimistic expectations for future growth, high prices seem entirely reasonable. Indeed, and somewhat worryingly, in the midst of a boom, high prices validate the optimism.