Is the market in a bubble?

Published in The Sunday Times on 31st August 2025.

There’s an inescapable whiff of mania coming from financial markets right now.

Amateur traders have assembled online again, pushing up the shares in struggling retailers and ageing consumer brands. So-called meme stocks like GoPro and Krispy Kreme have seen significant share price increases (and declines) in the last month. The share price of online house flipper Opendoor Technologies was catapulted over 350% higher in the past month, despite a stagnant U.S. housing market. Even as the president signs deals that leave US import tariffs at their highest in decades, signs of market froth have multiplied. 

The crypto market is cooking, with Bitcoin reaching new highs. Nvidia recently became the first $4tn public company with its shares up over 50% year-to-date – a rise at least somewhat justified by its earnings. A trend that’s harder to rationalise is the stampede into shares of smaller companies that have yet to turn a profit. Exchange and brokerage firm data reveal record-high margin debt, with massive trading volumes being attributed to retail trading of penny stocks and short dated options. 

At a more macro level, the S&P 500 index has hit a string of all-time peaks recently. And valuations are stretched. The S&P 500 is over 22 times forward earnings versus a historical average of 17. And the concentration of the index – 2% of the index constituents account for almost 40% of the value – is unprecedented. 

The US national debt is rapidly approaching US$37 trillion. 10-year Treasury yields are rising even at a time when the Federal Reserve has been cutting interest rates. And the dollar has been curiously weak. 

Talk of a bubble is unsurprising

What should a thoughtful investor do with this information? 

I think the starting point should be - how do we, or should we, define a bubble? A fascinating debate some years ago on this topic between Eugene Fama and Richard Thaler, both winners of the Nobel prize in economics, bears revisiting. 

Fama & Thaler on bubbles

Thaler offered a great example of a bubble - the CUBA fund. It was a closed-end mutual fund that had the ticker symbol CUBA but, of course, it had no financial interest in Cuba (it was illegal for US companies to do business there at the time). Most of its holdings were in the US and Mexico. 

For many years, the CUBA fund traded at a discount of about 10–15% of net asset value, meaning that you could buy $100 worth of its assets for $85–$90. Then, one day the price of the shares jumped to a 70% premium to NAV. That was the day President Obama announced his intention to relax diplomatic relations with Cuba. This meant that securities you could buy for $90 one day, cost you $170 the next. The substantial premium lasted for several months, finally disappearing about a year later.  “I call that a bubble” said Thaler.

Fama took the wind out of Thaler’s sails somewhat with his response. He dismissed the CUBA fund as a mere anecdote, saying there’s a difference between anecdotes and evidence. “I don’t deny that there exist anecdotes where there are problems. For bubbles, I want a systematic way of identifying them. You have to be able to predict that there is some end to it.” 

The difference between the CUBA example and much larger bubbles – like stock or property markets in 2008 - is that it is impossible to prove that prices in the latter were ever wrong. There is no clear smoking gun. It certainly feels like asset prices can diverge significantly from fundamental value. But to this day, we are still debating what is the best way of identifying bubbles.

Identifying bubbles before the pop is very difficult

Fama is correct, in that a sharp price increase of an industry portfolio does not, on average, predict unusually low returns going forward. We can all point to the examples where a rapid increase in prices led to a subsequent crash. But there are also examples where it didn’t.

Fama looks only at prices in his assessment of bubbles. Investors looking at stocks and sectors with large price increases have a good deal of other information to hand, such as valuations, turnover, issuance, patterns of volatility etc. I have seen papers which support the thesis that adding these factors to the equation helps forecast future returns. I’m still a little bit sceptical though.

I’m fascinated by the idea of being able to identify a bubble ex-ante. I have squandered much time and opportunity on the quest. Ultimately, I think you are being paid to bear the risk that the current run up in prices might end abruptly at some point and take a slice of your invested wealth with it. 

It’s uncomfortable to invest at market highs as it feels like a market sell off is inevitable. But the evidence I’ve seen would suggest that returns to investing at all-time highs are not that much different to investing at all other times.

The financial world will keep trying to find shape and pattern in the chaos that can engulf financial markets. I think it’s an emotional coping mechanism. I’ve moved on (I think), but I still keep some powder dry to take advantage when it happens. 
 

Source: Data is sourced from Bloomberg as at market close 31st December, returns are based on total indices in local currency terms, unless otherwise stated.

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on X at @gconno1.