The Bubble
The word ‘bubble’ drives me nuts, frankly, because I don’t think there’s anything in the statistical evidence that says anybody can reliably predict when prices go down.
— Eugene Fama, Nobel Prize Winner in Economics
Is this stock market a bubble about to burst? And, if so, what should an investor do about it? These are the questions we are now hearing frequently from clients (the more confident ask – “when will this stock market bubble burst?”)
So, are we in a bubble? And, if so, are there any actions an investor should take in response?
It is not as easy as it might seem to identify a bubble before the fact. In fact, it is not even easy to agree what a bubble is. Eugene Fama, a Nobel prize winner in economics said in his Nobel lecture of 2013:
…policy statements seem to define a “bubble” as an irrational strong price increase that implies a predictable strong decline… But the available research provides no reliable evidence that stock market price declines are ever predictable. Thus, at least as the literature now stands, confident statements about ‘bubbles’ and what should be done about them are based on beliefs, not reliable evidence.
As an example of Fama’s statement about “beliefs”, here is a quote from legendary Wall Street Journal columnist Jason Zweig about bubbles in an article from January 2014:
‘When everyone starts to use ‘bubble’ anytime prices go up, it’s probably not one,’ says Jason Hsu, chief investment officer at Research Affiliates, a firm in Newport Beach, Calif., whose investment strategies are used to manage approximately $150 billion in assets.
And here, twelve years later, in a column on May 8, 2026, is a quote from another Jason Zweig article about bubbles:
Owen Lamont, a portfolio manager at Acadian Asset Management in Boston, has written extensively about market extremes… Lamont looks back at history and identifies several indispensable ingredients for a market bubble: not just high stock prices, but also high volatility and trading volume, as well as the spread of what he calls ‘bubble beliefs.’ … If you’re at the gym or getting a haircut and everyone is talking about ‘Are we in a bubble,’ says Lamont, ‘that’s a pretty good clue that we might be in a bubble.’
So, in 2014, Zweig quotes approvingly an investment professional who says that it’s probably not a bubble when everyone is talking about one, and twelve years later he quotes approvingly an investment professional who says the opposite: when everyone is talking about a bubble, that’s a “pretty good clue” that we are in a bubble. As Fama would say, these are stories/beliefs, not evidence.
Jason Zweig writes thoughtfully about bubbles and many other investment topics. Pointing out this inconsistency between two articles that he wrote twelve years apart is done not to play gotcha but to illustrate how slippery and controversial the entire idea of a bubble is. In fact, he might say that he was not endorsing either quote; rather, the two quotes illustrate one of his main points: it’s very difficult to predict a bubble beforehand, and even smart investors use anecdotal short-cuts that often contradict each other.
In an interview with New Yorker magazine in 2010, Fama again expressed skepticism about the idea of bubbles: “I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time.”
For someone like Eugene Fama, even the story of Pets.com is not evidence of a bubble, but simply the market doing what it does best – adjusting prices in response to new information. Back in 1999, it was hard for stock analysts to figure out which of the new dotcom companies were going to be winners. With Pets.com and Amazon.com, some got it wrong and some got it right.
For example, in May of 1999 Barron’s writer Jonathan Laing wrote an article about Amazon.com entitled “Amazon.bomb,” which, as the title implies, argued that the company was a highly overvalued bubble stock that was sure to fail when traditional retailers like Barnes and Noble and Walmart fought back. For a brief period, he was correct, as Amazon lost 90% of its value before stabilizing and resuming its path to epic growth.
For Fama, each of these stories illustrate it’s next to impossible to determine which company is going to be the next Pets.com and which is going to be the next Amazon.com, especially during times of emerging technologies and societal changes. As more information emerges about the sustainability of a company’s operations – driven by so many factors like the quality of the management, the attractiveness of the product, the prevailing tastes of the consumers, etc. – the market efficiently and brutally adjusts the price of the stock.
Even though Eugene Fama is a Nobel prize winner and a legend in the field, other academics do not share his uncompromising positions. In an article in January of 2019 in the Journal of Financial Economics, Professors Robin Greenwood, Andrei Shleifer, and Yang You – all Harvard professors – published an article with the provocative title of “Bubbles for Fama.” In this article, they concede that Fama is correct that a massive run-up in price does not on its own predict low returns in the future.
However, they argue that market bubbles can be identified in advance if you combine high prices with a few other factors: sharp increases in trading, surges in new stock issuance, and a focus on new companies in emerging industries. But even they admit that their conclusion should be treated with skepticism, writing in their conclusion that “this evidence needs to be taken with a grain of salt. By the nature of the question, observations are scarce, very few are in the US, and these are far from independent observations.”
We certainly wouldn’t feel comfortable using the criteria from “Bubbles for Fama” to time the market or pick individual sector tops, and unless you possess extraordinary statistical confidence, we would not recommend you try it either.
Instead, in response to our original question – “what should an investor do” – our answer is the same one as we always give: diversify. This is also what is suggested by the Larry Swedroe article that we included in this month’s mailing, titled: “A Century of Stock Market Winners—and Why Most Stocks Failed to Deliver.”
In this article, Swedroe discusses the conclusions reached by Hendrik Bessembinder, a professor of finance at the University of Arizona, who researched the performance of every publicly traded stock from January 1926 to December 2025, 29,081 companies in total. What were his conclusions?
- Most companies fail. The average stock was only in the database for 11.7 years.
- Wealth creation is concentrated in a small percentage of companies. Of the $91 trillion in wealth created during this period, all of it was created by 1,081 companies, or 3.7% of the total.
- This wealth concentration is getting worse. From 1926 to 2016, the top 30 firms accounted for 31% of the wealth generated during this time. From 2017 through 2025, the top 30 firms accounted for 61% of all gains. Of these 30 firms, 19 of the top 30 (including Nvidia, Tesla, Meta, Eli Lilly, and AMD) did not even appear on the top 30 list prior to 2016.
- 59% of the companies in this sample of U.S. history – about 17,158 companies — underperformed US Treasury bills.
Swedroe’s conclusion from Bessembinder’s research is simple: “Owning the entire market is the most reliable way to capture the few enormous winners that are nearly impossible to identify in advance.”
Throughout stock market history, and especially during periods of rapid, uncertain change in technology and society, most companies and their stock will fail and – in hindsight – be labeled as overvalued. However, a few of these expensive stocks will win, and they will win decisively, or as my 14-year old might say: “the bad stocks will get cooked”.
The current valuation of the market – and of specific stocks within the market – is yet another argument for diversification, rather than a justification to market time. And it is not, and never will be, a rationalization to think that we individual human beings are smarter than the market.
