A Bubble Is Always Biggest Before It Bursts. Are You Watching This One?

So how big is the current market bubble? 2013 ended with the best annual stock market gains in 16 years. But with the bulls stampeding on Wall Street, why is economic growth so lackluster?

The answer lies within the bubble itself. What occurs inside this self-contained speculative fever is often an alternative reality where things simply aren’t what they seem. A financial bubble is characterized by a sudden rise in asset prices which pushes them to levels well beyond their value. We started this New Year with more than 86% of all stocks overvalued and 61% inflated by 20% or more.

2013 was an archetypal bubble year as the markets recorded 56 all-time highs. The Dow had its biggest gain in 18 years while the S&P surged to its highest level in 16 years. Since the recession-fueled plunge of 2008-2009, the Dow has increased 143%, the S&P 500 165%, and the NASDAQ an astonishing 213%. It has been almost 2 ½ years since stocks fell in any measurable way. This is far from business as usual and clearly has all of the characteristics of a massive balloon on the brink of puncture.

How did we get here? Simply stated, the Fed unleashed mountains of cash. They bought Treasury Bonds in droves. They saved auto companies and banks with pricey bail-out programs. They have kept interest rates at historic lows and increased the money supply by billions of dollars, while adding trillions to our National Debt.

We have witnessed the most aggressive monetary policy in US history, and it has clearly been a boon to investors looking to take advantage of cheap, paper assets. And while Quantitative Easing was enacted to improve the economic predicament of Main Street, it has primarily succeeded in enriching the plush portfolios of Wall Street.

There’s no doubt that stockholders will soon look to retrieve their profits. This already ranks as one of the longest bull runs in history and when institutional investors start removing their money from the market, the sell-off will begin. What remains to be seen is how quickly trading will accelerate and how rapidly losses will accumulate.

History tells us that at these heights the correction could be severe and the recovery could take years. Of the historical bull markets that have had an over 100% valuation gain (like the current one) … including the bull runs of 1953-1956, 1984-1987, 1990-1998 and 2002-2007, the average correction was over 32%. This is a very sobering number.

When the Fed cavalierly set out to bolster the economy and free it from the grasp of The Great Recession of 2008, it embraced an ultra-easy money policy that has cost too much, lasted too long, and resulted in one of the largest market bubbles in history. A correction is clearly in the tea leaves and anyone familiar with market swings knows that a return to equilibrium pricing after massive over-valuation is never subtle.

When the bubble does burst, the only way we’ll see it coming is if we are watching …and they only way we will protect our wealth and everything that we have built-up and saved for, is if we are prepared.