1. Standard Deviations of Valuation: Look at traditional metrics – valuations, P/E, price to sales, etc. — to rise two or even three standard deviations away from the historical mean.
2. Significantly elevated returns: The S&P500 returns in the 1990s were far beyond what one could reasonably expect on a sustainable basis. The years around Greenspan’s “Irrational Exuberance” speech suggest that a bubble was forming:
And the Nasdaq numbers were even better.
3. Excess leverage: Every great financial bubble has at its root easy money and rampant speculation. Find the leverage, and speculation won’t be too far behind.
Bubbles can create investment opportunities or act as predators for risk managers. While much academic research previously focused on how they formed, papers like this are beginning to provide toolkits for traders and risk managers to see, in real-time, the formation and presence of bubbles in a range of asset classes.