4 Ways to Survive a Stock Market Bubble

Signs of a market bubble are building, according to the Wall Street Journal. Columnist James Mackintosh cites these examples: fading fears about a repeat of the 2008 financial crisis; increasing expectations that noninflationary stable economic growth is here to stay; growing investor preference for corporate reinvestment of profits rather than returns of capital through dividends and share repurchases; a comeback for risky investment vehicles such as CDOs; the highest levels of bullish sentiment among individual investors since 2010 and among institutional investors since 1987; investment managers with record or near-record levels of risk in their portfolios; and high stock valuations by historic standards, at levels last seen during the dotcom bubble. (For more, see also: Wall Street's Exuberance May Signal Coming Bear Market.)

Other signs that he could have added include these: escalating optimism by analysts about corporate earnings and reduced hedging activity by investors. Nonetheless, Mackintosh does not believe that we're in a broad-based market bubble just yet, but the surest sign, he says, is "people buying things they know are overpriced in the hope of selling them on at even higher markups to a greater fool." He says we're there already with bitcoin-related stocks, and tech stocks are getting close. He also offers four defensive strategies for investors to adopt. (For more, see also: How to Prevent Your Stock Gains From Vanishing.)

1. Exit Early

Put aside fears of missing out on further gains, and "sell into strength," Mackintosh advises. You can't time when the bubble bursts and the next bear market begins, so turn your paper profits into realized gains as the bubble builds. You don't want to ride the market all the up then all the down, giving back all your gains, as did many who stayed with tech stocks all the way from mid-1996 through October 2002 during the era of the dotcom bubble.

2. Exit Late

This is the riskier alternative of waiting until the bubble pops before selling. The problem is that you simply cannot know when the high has been reached, or when the subsequent low has been hit.

3. Play It Safe

You can stay in the market, ride out the downturn by rotating into higher-quality, more value-oriented stocks that are not being chased by the crowd. The problem, Mackintosh says, is that quality stocks have gotten expensive and value stocks could have more downside before they return to fashion. (For more, see also: How To 'De-Risk' Your Portfolio For A Crash.)

4. Venture Abroad

Fund manager Jeremy Grantham is among those who suggest that investors shift their equity holdings toward emerging markets which have lower valuations. However, Mackintosh observes, the popping of a market bubble in the U.S. probably will send overseas markets downward in its wake, at least in the short run.

Stay Disciplined

Once you pick a strategy, Mackintosh advises you to stick with it. The intelligent long-term investor, he adds, looks to survive bubbles, and shuns the greedy pursuit of transitory gains.