JOHANNES EISELE/AFP via Getty Images
- The stock market is not yet in a bubble, DataTrek co-founder Nicholas Colas said in a note on Wednesday.
- Two conditions that define stock market bubbles are fast rising valuations and retail investor fervor, according to the note.
- “We don’t have the first, and the second is just starting,” Colas said.
- Sign up here for our daily newsletter, 10 Things Before the Opening Bell.
The stock market is not yet in a bubble, but a “baby bubble” might be forming, DataTrek co-founder Nicholas Colas said in a note on Wednesday.
In order for a bubble to even form in the stock market, two conditions are necessary: fast rising valuations and retail investor fervor, according to the note.
“We don’t have the first, and the second is just starting,” Colas said.
Based on the Shiller PE ratio, the bubbles of 1929 and 2000 were evident when a sharp move higher in valuations occurred. It’s about the rate of change in valuations, not the absolute valuation levels that indicate a bubble is present, according to the note.
So far, the current reading of the Shiller PE ratio does not indicate that a bubble is forming in stocks, the note said.
"To our eyes the current-day red dot above lacks the antecedent spike of either 1929 or 2000, so by this measure we can't call the current US equity market in a bubble," Colas said.
While the stock market is not in a bubble yet, it is possible that one could be forming, according to DataTrek.
Heightened Google search trends for terms like "buy stocks," "stock bubble", and "stock market bubble", have increased recently. The search trend data represents preconditions to create a stock market bubble "in terms of social attention on equities," Colas said.
Retail investors have piled into the stock market since the COVID-19 pandemic, with $0 commission trading apps like Robinhood making it easier than ever to begin buying and selling stocks. The heightened retail activity was apparent last month after a Reddit forum helped spark a gravity-defying short-squeeze in shares of GameStop.
But while more retail investors are participating in the stock market, that doesn't mean it's time to sell stocks, the note said.
"We have not yet had the sort of valuation run up that says it's time to sell," Colas said, adding that investors should remain invested in US large cap and emerging market stocks.
And while trying to call the top of a bubble remains appealing for investment professionals, it's ill-advised.
"Even if you're more bearish than us, remember that the end of the world only happens once so timing is everything for that trade. And early is the same as wrong," Colas concluded.