Are we in a bubble?

See the graph below of Gross Domestic Product (GDP) vs Gross Domestic Investment (GDI). The data is standardized so you can see the relative trend between the two. The graph shows the large 2007 bubble before the 2008 pop. Currently it seems like investment is keeping fair pace with GDP.

What is a bubble? "Bubbles are typically associated with dramatic asset price increases followed by a collapse. Bubbles arise if the price exceeds the asset's fundamental value. This can occur if investors hold the asset because they believe that they can sell it at a higher price to some other investor even though the asset's price exceeds its fundamental value." - Markus Brunnermaier at Princeton

In short, a market bubble is a time when public enthusiasm and greed over profiting from the stock market greatly exceeds its true value. Thus the "price" of investments goes up well beyond what it is worth. If we assume that total investment (GDI) grows at the same rate as the economy (GDP), total investment should never much exceed total gdp. If it does, either GDP should catch up, or the value of investments will go down.

What is Standardized Data? Standardized data is a way of making the average of the data be 0 and the variance be 1. This allows you to look at the relative variation between two sets of data. It is calculated by taking each data point, subtracting the mean, and dividing by the standard deviation. In math terms, this is x-standardized = x - average / standard deviation. This page, and this page, has more info.


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