Look out for these key signs of a stock market bubble

Peter Hodson

Thu, October 23, 2025 at 12:21 p.m. EDT 5 min read

Every day at 5i Research, we see some version of a current concern about the markets. An “expert” in the media says something, or we get a question from a customer, along the lines of: “The stock market has gone up too much, we must be in a bubble.” First, just because something is good does not mean it is about to turn bad. Fortunes are made in the market by not selling a winner too early and staying invested despite all the doom-sayers telling you to get out. But to address the “bubble” concern, let’s look at what defines a bubble and take a look at how the current situation does, or does not, match past market bubble tops.

A stock market or asset bubble is characterized by prices rising far beyond their fundamental value, driven more by emotion and speculation than by earnings or productivity. Economic history shows that bubbles follow recurring patterns and exhibit identifiable warning signs across valuation, sentiment, leverage, and liquidity cycles.

Here are key signs of a bubble.

Bubbles can occur when market valuations far exceed historical norms relative to fundamentals such as earnings or book value. Common metrics include the price-to-earnings (P/E) ratio or the cyclically adjusted P/E (CAPE) ratio; when these remain well above long-run averages, it often signals excessive optimism. ​Many pundits think the market is overvalued right now, but we don’t think it is, at least to the same degree as many think. Earnings are rising and interest rates are falling. This should allow for higher valuations. The S&P 500 is at a forward price-to-earnings of 23 times right now. Certainly not low on first blush (it was as low as five times in the early 1900s), but if we look at data past 1990 the average has been 24 to 25 times. Most would say it is “fairly priced” not “bubble priced.” The index price/earnings multiple has been as high as 130 (in the dark days of the financial crisis, when companies were hardly making any money, if at all).

Leverage is often blamed for the 1987 stock market crash, about 38 years ago. Rising use of borrowed money, such as margin debt in equities or high loan-to-value ratios in real estate, amplifies gains during bull phases and magnifies losses afterward. Easy credit or relaxed lending standards frequently accompany bubbles.​ Currently, there is a lot of concern about margin debt. According to the U.S. Financial Industry Regulatory Authority (FINRA), margin debt is at about US$1.1 trillion. Sure, it is a big number, and is at a record. It represents two per cent of total S&P 500 market value, and is up 35 per cent in the past year. But again, it may not be as bad as it sounds. The S&P 500 is up about 15 per cent in the past year so some margin expansion is expected. Lower interest rates also help investors manage their debt exposure. And, two per cent of the S&P 500 does not sound like a lot, considering expected earnings growth forecasts in the 10 per cent or more range for next year. Still, margin debt is certainly something to watch, and may be a sign of future troubles.