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Market Realist Chronicles: Protect your investments from a stock market bubble

Market Realist Chronicles: Protect your investments from a stock market bubble (Part 1 of 5)

A simple framework for deciding if you should stay in stocks

An exciting week for stocks

Last week was exciting!

The jobs report took the S&P500 (SPY) and Dow Jones (DIA) to fresh new highs. This is the third new peak in less than a month.

The market keeps brushing off bad news from abroad.

But is this reaction rational? Could the market come tumbling down just as quickly as it’s gone up?

Today, I’ll outline for you a simple framework that you can apply in any market scenario to understand what’s going on and decide whether to hold on for the ride or sit on the sidelines.

US Equities 2014-07-08Enlarge Graph

This market just won’t quit. Every time we think it’s showing weakness, it bounces right back.

For example, since the beginning of June, the S&P500 (IVV) has rallied 3%. And since the dip you saw in April, it’s increased 9%. From the February lows, it’s risen by almost 14%!

So does that mean that the market is overvalued now? Or undervalued?

How are you supposed to know?

I. The first step in my framework is to understand the past before jumping to conclusions

It’s human nature to make decisions based on the most recent or most readily available data. But that’s a flawed approach.

Within the stock market, often, people turn to a certain ratio to help guide their decisions.

Interestingly enough, for many investors, the price-to-earnings is the key indicator to follow. But many investors don’t fully understand this ratio. What does it mean? Is it truly useful? How do you know when it’s too high or too low?

Read on to understand why the price to earnings ratio may not be the best metric to follow.

This is an excerpt from our Market Realist Chronicles newsletter. Register for free to join 7,500+ investors who receive up-to-date Market Realist Chronicles insights in their inbox—immediately as we publish each issue.

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