Market Bubble? NerdWallet Expert Reads the Signs

The stock market has been on a strong run, but it’s not clear how long it will — or can — last.

With elevated valuations, persistent inflation, shifting market leadership and AI enthusiasm reaching a fever pitch, who could blame investors for asking the uncomfortable questions: Is this rally built on solid ground? Or is there an underlying bubble about to burst?

To make sense of it all, I sat down with NerdWallet investing writer Sam Taube to unpack what’s driving the market, why bubbles are nearly impossible to spot and practical steps investors can take to protect themselves amid so much uncertainty.

Anna Helhoski: Are we still in a healthy bull market, or are we starting to see signs of a bubble?

Sam Taube: The short answer is that stock market valuations are a little high, but not drastically so. The S&P 500’s price-to-earnings ratio is a little above its long-term high, but it’s not ludicrous.

What makes these high valuations a little bit more concerning is that interest rates are also high (and potentially rising in the future).

Ryan Sterling from NerdWallet Wealth Partners recently introduced me to a more technical valuation measurement called the “earnings yield gap,” which takes into account the S&P 500 index’s price level and earnings compared to the yield on the 10-year Treasury bond. I don’t wanna get too bogged down in explaining this, but we recently wrote about it in the Nerdy Investor newsletter if folks wanna learn more about why rising rates and high valuations are a somewhat worrying combination.

AH: How valid are the concerns that this market could be in a bubble?

ST: I want to address the AI-generated elephant in the room, which is the idea that there’s an AI bubble. There is a “vibes” argument for it. Late last year, we polled more than a dozen economists about this question and a significant majority said, yes, it feels like there’s a bubble in AI investments. Many said that the current climate — where AI is all over the news and venture capitalists are throwing so much money into it and it’s being shoehorned into every product — kinda reminds them of the dot-com bubble in the late ’90s.

But when it comes to the numbers from the big tech companies that have gotten rich on AI, it’s actually surprisingly hard to back up the bubble theory. The big players in AI, like Nvidia, Microsoft and Google, have market caps in the trillions of dollars, which sounds like an absurd number — except that they have hundreds of billions of dollars in revenue and earnings. Their valuations are actually pretty reasonable given the very real amount of money that they’re making from AI-related services.The tough thing is that bubbles can only be identified in hindsight. There’s no surefire diagnostic for them. Tech bubbles in particular feel obvious when we look back at them in hindsight — “oh, there was so much irrational exuberance about internet companies in the 1990s” — but there are lots of other cases where tech companies with high valuations and lots of media hype eventually “grew into themselves.” Tesla and Meta come to mind as examples.

AH: Since bubbles are so difficult to identify in real time, how should investors think about managing risk?

ST: This really isn’t something you can sniff out. The best anyone can do is try to strike a balance between profiting from a strong market (in case it isn’t a bubble) and having some downside protection (in case it is).And that’s a matter of investment diversification. There are different rules of thumb you’ll hear from financial advisors — some say, don’t have more than 10% of your portfolio in any one stock, others are more conservative and say, no more than 5% in any one stock.

One thing to watch for is that some index funds are heavily concentrated in the big tech stocks, such that if you’re just investing in the S&P 500 or the Nasdaq 100, you might unwittingly be breaking the 5% threshold with your allocation to Nvidia or other mega-caps. One of our latest Nerdy Investor issues talks about different types of index funds that solve this problem, like world stock market funds.

AH: The market’s favorite stocks seem to be rotating — from tech, to commodities and now chipmakers. What does that kind of rapid shift tell you?

ST: I hesitate to read the increase in options trading as an economic signal. I think it’s more the result of investors having access to a lot of cheap options trading platforms (several of the brokers in NerdWallet’s Best Options Trading Platforms roundup don’t charge any kind of contract fee anymore) and also the proliferation of options trading content on social media.

AH: What would it take for the market to find its next leader? What might influence that?

ST: I think a big factor in the shift toward more “defensive” investments is the realization that interest rates probably aren’t getting cut again anytime soon, and could even start rising again if the recent uptick in inflation persists. If rates increase again, we may see a further shift toward defensive sectors — consumer staples, healthcare, utilities, etc.

About the author

Anna Helhoski is a senior writer covering economic news and trends in consumer finance at NerdWallet. She is an on-air contributor and producer of Money News segments for NerdWallet’s Smart Money podcast. She is also an authority on student loans. She joined NerdWallet in 2014. Her work has been syndicated in news outlets nationwide including The Associated Press, The New York Times, The Washington Post, The Los Angeles Times and USA Today. She previously covered local news in the New York metro area for the Daily Voice and New York state politics for The Legislative Gazette. She holds a bachelor’s degree in journalism from Purchase College, State University of New York.

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