Dalio: 6 Signs Of A Market Crash On Its Way

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In this video Ray Dalio shows us 6 signals to watch out for in terms of a bubble forming and a crash on its way...

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Ray Dalio, he’s an investor who runs the largest hedge fund in the world called Bridgewater. One of his specialties is looking at market cycles. Are markets poised to crash, are they poised to go up, what are the patterns that we can see.

In this video we go over Dalio’s 6 signals that he uses to determine if the stock market is in a bubble. But he’s not just looking at bubbles, he’s looking in particular for bubbles that are about to pop and crash the market…

Sign 1: Prices Are High Relative To Traditional Measures

First is the prices relative to traditional measures. So one of the easiest ways we can do this is simply by looking at the p/e ratio. If we look at the S & P 500 p/e ratio we can see that it’s sitting at a high amount right now, 45.3. This is much higher than the average that we see of 15 across time.

But Dalio makes a good point, and says we have to compare this to other asset classes, this way we have something to measure it against. So in order to do this we have to do a little bit of math so stick with me.

The p/e ratio currently is 45.3 if we do a little bit of algebra and reverse it, this implies and earnings yield of 2.2%. So if there was no growth in the market we would get a 2.2% return.
But we need to include growth and right now business growth in the USA is around 2% over the past 10 years.

So if we add the 2% growth on to the 2.2% earnings yield we get a total return of 4.2%! Now if we take a look at the bond market, bonds are currently yielding around 1.5%. That’s the 10 year treasury.

So if we compare the return we get in the stock market relative to the return we can get in the other main asset which is bonds, the stock market is not overly expensive. That is why Ray Dalio when he looked at this first measure, he got somewhat frothy conditions relative to previous market bubbles. That’s for the market as a whole.

However if you look at emerging tech, it’s a different story in terms of price and that reads frothy. So note that one down and let’s move on to the second measure, which we’ll have in Dalio’s own words.

Sign 2: Prices Are Discounting Unsustainable conditions

And as you can see right now, in terms of supply and demand, the way investors are buying it’s in a relatively sustainable way in terms of the overall market. In terms of emerging tech, that’s where we have a bit of a problem. There’s a frothy amount of unsustainable investing going on there….

Sign 3: New Buyers Have Entered The Market

With signal 3 Dalio takes a look at the new buyers that have entered into the market. Ones that generally don’t know too much about investing, have no experience and are simply investing because they see their friends making money in the stock market.

The example Dalio gives is let’s say you’re at a cocktail party for work. And people come up to you and they start talking about their recent investments in the market. And you ask them well have you ever invested before? They say no. Did you buy the stock at a reasonable price? They say, I don’t know how to calculate intrinsic value. You ask, do you even know what a stock is and they fumble around for an answer.

You find out that they’re simply investing because the stock market has been on a 12 year bull run and has made people rich. When you have a lot of new investors entering the market, with little understanding of it, it’s a signal of a bubble. Right now, in the total market, levels are at a frothy amount and in emerging tech it’s showing big signs of a bubble. So many new investors, buying, simply in the hopes of becoming rich. This leads us to the 4th sign which is.

Sign 4: There Is Broad Bullish Sentiment

This is a signal where, the general vibe in the market is that you can only make money. The stock market will only go up, there’s lot of quick profit to be made, you just need to be invested in the market.

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DISCLAIMER: It's important to note that I am not a financial adviser and you should do your own research when picking stocks to invest in. This video was made for educational and entertainment purposes only. Consult your financial adviser. * Some of the links on this webpage are affiliate links. This means at no additional cost to you, we earn a commission if you click through and make a purchase and/or subscribe. This has no impact on my opinions, facts or style of video.