The Stock Market is a 10% Move Away from Bubble Trouble

Stock investors could be about to take a bath

by John Coumarianos
Market Watch

When is a bubble really a bubble? Jeremy Grantham, founder of Boston-based asset manager Grantham, Mayo, van Oterloo (GMO), defines a bubble as when a market’s valuation reaches a two standard deviation or “two-sigma” move, from its long-term average.

By that measure, the S&P 500 will hit bubble territory at 2,400 — about 10% higher than where it is now.

To assess whether a market risks being in a bubble, GMO looks at two main valuation metrics: Tobin’s Q (price to replacement cost of assets), and the Shiller PE (price to past 10-year real average earnings). GMO then calculates the long-term averages of these metrics and assesses how far away the market is from them. The firm also uses real price data.

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