The Indian stock market, particularly the Sensex and Nifty, has been on a remarkable upward trajectory, drawing in hordes of investors. For some, this bull run seems unstoppable, fueled by optimism and the belief that the economy is on a steady growth path. However, as an investor who believes in reasoning from first principles, I can’t help but notice the warning signs of a bubble.
Let’s break down the four classic indicators of a stock bubble and see how they apply to the current market:
- High Levels of Borrowing for Stock Purchases:
Margin trading has become increasingly popular, with investors borrowing heavily to buy stocks. This leverage amplifies gains in a rising market but also magnifies losses when the market turns. The growing reliance on borrowed money to buy stocks is a red flag. When investors start using debt to chase returns, it’s a sign that the market is driven more by greed than by sound financial principles. It’s a house of cards that can easily collapse when the winds change. - Share Prices That Can’t Be Justified by Economic Growth:
While the stock market continues to soar, the underlying economic fundamentals tell a different story. The Indian economy, like many others, has faced significant challenges in recent years—pandemic-related disruptions, inflationary pressures, and geopolitical tensions, to name a few. Yet, stock prices have outpaced the growth of the real economy. This disconnect between the market and economic reality suggests that stock prices are being driven more by speculation than by genuine value creation. When share prices become divorced from the underlying economic reality, it’s only a matter of time before the market corrects itself. - Overtrading by Retail Investors:
The influx of retail investors into the stock market has been unprecedented. While financial inclusion and democratization of investment opportunities are generally positive developments, they can also be a double-edged sword. Many of these new investors are driven by the fear of missing out (FOMO) rather than a deep understanding of market fundamentals. The result is overtrading—buying and selling stocks frequently in the hope of quick profits. Overtrading inflates stock prices temporarily but often leads to volatility and eventual downturns when the bubble bursts. - Exorbitant Valuations:
Valuations in the Indian stock market have reached levels that defy logic. Price-to-earnings (P/E) ratios for many companies are sky-high, often without the earnings growth to back them up. This kind of irrational exuberance is reminiscent of previous bubbles, where investors convince themselves that “this time is different.” But history has shown time and again that such valuations are unsustainable. When the bubble bursts, the fall is swift and painful.
So, when will the Nifty crash? Predicting the exact timing of a market crash is a fool’s errand, but it’s clear that the ingredients for a bubble are all present. The market can remain irrational longer than we can stay solvent, but eventually, it will correct itself. Investors would do well to heed the warning signs and approach the market with caution.
Remember, it’s better to miss out on some potential gains than to be caught unprepared when the bubble bursts. As always, reason from first principles, stay grounded in reality, and invest with a margin of safety. The market rewards patience, discipline, and a contrarian mindset—qualities that are in short supply during a bubble.