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We are definitely in an asset bubble and I will attempt to prove that here. When bubble-like conditions occur we often see stocks that would otherwise be beaten up increase like the rest of the market. They say that a rising tide lifts all boats, and that is exactly what happens when asset bubbles like the one we are in today govern the sentiment on the street. It happened during the credit bubble, it happened during the Internet bubble, and it is happening again right now in front of our eyes.

The details I will offer here support my thesis of us being in an asset bubble, and our members can follow along using our earnings analysis pages (registration required), but as you do keep in mind that asset bubbles often end badly. Of course, a rising tide lifts all boats, but when the tides turn all stocks also often fall with the market. This is the other side of the coin, and it goes hand in hand with markets that are in bubbles. When bubbles burst, not only do the stocks that should not have increased fall, but the best of the best also come under serious pressure.

The question, of course, is when declines will begin.

Using the earnings analysis I have provided, which is updated through last Friday, I have drawn the following conclusions about earnings and price movements of these important sectors to prove a divergence in earnings and price, which usually goes hand in hand with bubbles.

As you will see, these sectors have increased in price in 2o13 while they are experiencing earnings and revenue contractions. This is typical of asset bubbles:

  • Materials: -15.3% EPS growth; The Materials ETF (XLB) is up 10% YTD.
  • Staples: -4% EPS growth; The Staples ETF (XLP) is up 20% YTD.
  • Telecom: -14.17% EPS growth; The Telecom ETF (IYZ) is up 13% YTD.
  • Energy: -5.4% Revenue Contraction; The Energy ETF (XLE) is up 15% YTD.

When investors buy stocks in asset bubbles they usually do not look closely at what they are buying, that is what makes bubbles, and that is true for each of the sectors above. If they did, if a true valuation analysis was conducted, bubbles would never exist, but they do because the market is emotional, both greed and fear play significant roles, and there is nothing anyone can ever do to stop that from being true. Instead, we must accept what the market is, realize what the market can do by understanding what it has done, and in that way educate ourselves properly so that we are ready for the next major market move.

Although the market can continue to increase from current levels, the asset bubble we are in today will burst at some point, the market does not need to increase by another 10% for that to happen, and therefore we all should remain proactive and in control of our risk because when the music stops the people that are left holding the bag are likely to experience wealth destruction not unlike the debacle that followed the Internet bubble and the credit crisis most of us are still very familiar with. Offering proactive strategies is what we have been doing since 1.2.2000, and it is what we will continue to do through the cycles that lie ahead.

Source: Sector-Specific Asset Bubbles