Ray Dalio: Are we in a Stock Market Bubble?

So Ray Dalio is back on YouTube and his most recent video is actually a really cool 10 minute explainer on whether we're currently in a stock market bubble. Now Ray is obviously the founder of Bridgewater Associates, the most successful hedge fund the world has ever seen. He's been investing for over 50 years and throughout his investing career, he has studied the history of economics in insane detail to help him understand how various economic situations tend to play out in the market.

Although I must say, for someone that's so successful, I was very surprised to see his latest video clearly hashtag sponsored by Robinhood.

"Hi everyone, uh, it's so good to be here on behalf of all the people that are being helped by Robinhood."

Um, yes, that's obviously way out of context. Ray is definitely referring to this Robinhood as opposed to that Robinhood. But anyway, as I said, this video is all about Rey analyzing whether we're currently in a stock market bubble, and to do so he breaks it all down into six points.

So let's roll the intro and then get into point number one.

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This video is sponsored by Stake. Download the Stake app today and use the referral code AWC to get a free stock when you fund your account. Details in the description.

First, you know how high are prices relative to the traditional measures of, um, prices is a consideration. For example, you know, are PEs high or yields low and that kind of thing? That's a consideration, but it's not what I mean by a bubble. Let's say for example, you can have prices high which means returns low, and you can have that go on for a very long time. That doesn't mean a bubble pops.

So I'm really looking at whether you get a pop but still it's an ingredient. So how high prices are relative to traditional measures. And Ray classifies the market as somewhat frothy on this point. I find this really interesting because I would call this one a bubble. Even if we look at a measure like the Schiller P, which is kind of like a big P/E ratio for the S&P 500, we can see it currently sits at 38, which is almost the highest it's ever been, certainly higher than 1929 and 2008, just not quite as high or as steep as the tech bubble.

But the reason Rey says somewhat frothy as opposed to full-on bubble is because he compares stock valuations to bond valuations. He gave the example that, you know, if you invested in bonds right now, you're roughly accepting a 75 times price to earnings ratio on these bonds, depending on what bond market you're looking at. So if stocks right now have a P/E ratio that's currently 38, that still seems like a better place to park your money than in bonds. So that's why Ray doesn't really call this point a full-on bubble.

But all right, let's move on to point number two.

The second is prices are discounting unsustainable conditions. So unsustainable starts to be part of this picture of a bubble. Unsustainable means that by the nature of the buying, whoever is doing the buying and how of that supply and demand, that means that that won't be sustained and that produces a correction or prices going down.

Now I thought Ray could have done a slightly better job at explaining this point because I'm not sure I exactly understand what he's talking about here. But I believe what he's saying is that this criteria examines whether share prices now reflect unsustainable growth rates for the future, because the way that you value businesses is you grow the cash flows out into the future by a certain growth rate, then you discount that back to what you would pay today for those future cash flows.

And this is basically how all investors value stocks. Now I won't go into the details here, but if you are interested in how that actually works and you want to see an example, then check out the video that's coming up on the screen right now. But if a share price is really high today, that means whoever bought the stock at that price is clearly expecting monstrous growth in the future.

So I think what Rey is really saying with this point is, you know, are prices today reflecting unsustainable growth rates that investors are using in their valuation models? And for him, interestingly, he doesn't believe so. So Ray clearly sees an environment where growth can continue out into the future.

All right, let's move on into points three and four.

And then, um, there's this speculative element. Number three, so one of those measures of the speculative elements is new buyers in the market. They're attracted in the market, you know, it's the sort of thing where you go to a cocktail party and people who are never involved in the thing are investing in it, and that could be tech stocks and it could be real estate and whatever. But you know, they're drawn in, and that there's a big bullish sentiment.

So everybody wanting to have these things makes you feel dumb, that kind of thing. So Ray calls this one frothy and I definitely agree. Right now, there are a lot of new market participants and a lot of them are getting real speculative with their buyers.

I mean, Robinhood alone now has around 18 million users and that's versus 7.2 million just one year ago. So there's huge amounts of new buyers and they're cashed up and they're ready to go. They're everyday Joes, they have the money and they want in on this game we call investing.

And Ray is right when you start hearing people talk about, you know, AMC and GameStop at a cocktail party, that's when you start getting worried. I mean, anecdotally, at the clinic I used to work at, all the physios during their lunch break started talking about buying Bitcoin, and that's definitely a sign that a bubble is forming.

So I think Rey is definitely right on this one. And then point four, you bet there is huge bullish sentiment. As Ray says, this is the fear of missing out element that, um, you know, if you don't own this stuff you feel stupid.

You know, people get in on trends and that makes other people feel like they're missing the boat. So then they get on, which then leads to another wave of people that get on the ship and another wave and another wave. And this happens at all levels too. It's not just retail, right? This idea of being the poor sod that's left holding the bag that gets the big money managers chasing each other as well just trying to beat the other guy.

So I can definitely understand why Rey says points three and four are looking frothy, and I certainly agree.

Okay, lastly, let's have a look at Ray's fifth and sixth point or criteria.

And then also, uh, number five on my list is big purchases, uh, forward purchases. You know, like if somebody's buying apartments that they don't own because they think that the apartments are going to go up. Or back in the days where I traded a lot of commodities, I would watch that those who used commodities would rather than buy from hand to mouth, they would get a lot of forward coverage. In other words, buy inventory to protect themselves against the prices going up.

And so when they go from, as we have recently seen in commodities, when they go from not having forward coverage because prices went down and they kept falling, and they say, I don't want to own it to, and then it going up and they say, I want to be protected against it going up, that movement causes a lot of mine and so on.

So that's buyers that have extended those forward purchases are an indicator that I use. So there you have two interesting points. Firstly, a big sign of a bubble is definitely people being able to and committing to a lot of debt. That's point five on Rey's list.

This is just a classic setup. It's what happened in 2007. You know, people could buy five houses with no income. Um, that's the stripper scene if you've seen the big short. The scene with the stripper, you know, it's where she says, I have five houses and a condo.

Um, and obviously people en masse overextending themselves with debt is just a massive setup for a bubble that can burst very easily because just a little blip can trigger a huge wave of people just starting to sell their assets because they can't keep up with the cost of their debts, and they can force downward price pressure on whatever market you're looking at—stocks or real estate or whatever—and they can snowball into a big crash, no doubt about it. So that's point number five.

And then point number six is, you know, people buying stuff now, stocking up because they fear that prices will be worse in the future. And honestly, I'm not sure why this is a bubble indicator. Maybe it's because, you know, the buying is brought forward so business sales look artificially strong now and then will look weak at some point in the future when there's obviously a lull in sales because of that pull forward.

But honestly, I'm not actually too sure on this one. Maybe I'm missing something obvious. Maybe I just don't know. So please let me know in the comments if you are, if you're getting this point way better than I am.

Um, but anyway, that's point number six. And if you have a look at Ray Dalio's conclusion of all these factors today, you can see that Ray Dalio doesn't seem to think we're in bubble territory just yet. You know, a few of these criteria are frothy in his mind, but if you compare that to his conclusions of the previous three big crashes, you know, he doesn't seem to think that we're in any sort of danger.

One thing I find interesting, though, which he didn't have to do but he decided to include anyway, is, you know, his conclusions on emerging tech. See in that space, he indicates three out of the six criteria are in that bubble stage. So I think reading between the lines here, I think Rey is saying that, you know, he doesn't believe we're in imminent danger of the market exploding, but watch out for emerging tech.

But one thing I wanted to touch on lastly is that Ray says in this presentation that he doesn't actually apply these criteria to the market as a whole. Normally, he actually uses this framework to judge individual businesses, and I think that's really smart. So I wanted to touch on it because we know that we can't time the market. Nobody can.

So instead of using a framework like this to try and make a market prediction, trying to predict a market crash for example, instead use it to help you analyze the individual companies that you've been looking at to invest in. That's where it might be useful.

This table here that I'm showing shows for the stock market as a whole those items that, you know, are we in a bubble? Is the stock market in a bubble? Well, I apply that basically that framework to all individual securities and I do that in a systematic way because my process is to write down the criteria, to use filters and so on, and try to see which are in a bubble.

So, uh, there are different stocks—some are in bubbles, it seems to me, some are not in bubbles, and the stock market as a whole is indicated by that table. Let me just go to the next chart.

So there you go, use it for individual stocks and don't get caught up in making market predictions.

All right, that will just about do us for today's video. I'll let Ray take us home today, but before I do, please remember to leave a like on the video if you did enjoy it or if you found it useful. Subscribe to the channel, of course, if you have not done so already.

Also, if you're looking for a step-by-step video course on how to start investing, either actively or passively, then you can check out Profitful. Links are in the description below. But with that said, I will see you guys next time in the next video, and now let's have Ray Dalio take us home and give us your thoughts, give us your conclusions, Ray, on the current state of the stock market.

I'll see you guys next time.

"You can't say the stock market is in the highest a bubble. You can't even say that it's necessarily in a bubble. You have to distinguish which ones, which stocks are in a bubble or have been in a bubble from those that are not in a bubble. There are a lot of stocks that aren't, and that bubble is a little bit like the bond markets bubble. So I hope that gives you a little bit of flavor of bubbles and how I look at them and where we are. Thank you."

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I'll see you guys in the next video.

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