Do I think stock market is a bubble ?

During my recent chats with some investors, I was questioned by most of them about my thoughts on the "stock market bubble". I realized that there are whispers in the air about the stock market being a bubble currently. My answers to the investors, which I even feel has been, "i do think that the markets are overvalued but I do not believe it's in a bubble. So yes, if you want to invest new, I won't disagree with your decision of waiting a bit". Having said that though, I would like to reiterate that I feel there's a need for correction but not a crash.

Discussing bubbles is a tricky thing because the term "bubble" in financial markets do not have a clear definition yet. It's still debated amongst economists about parameters or the way bubble should be defined. So, not only we lack a definition but unsurprisingly we lack tools to judge if a market is indeed in a bubble or not. The bubbles are only realised in hindsight.

But then a genuine question arises that how do we deal with such a condition. How do we take a realistic decision when our savings are at stake. Although there's no objective answer, but I believe to think of the current situation with an example and hopefully, it would help us understand the current stock market scenario (although everyone need not agree with it, but I am open to constructive criticisms)

Let's take a startup that is in the space industry. Now its vision is to take humans to Mars and colonize Mars. However, the startup is in the nascent stage. In this phase, the startup is trying to build a rocket that can take them to outer earth orbit while carrying some hundred grams. They have all theory done, the business model made and on paper clearances. They want to now go on and build a rocket and start testing their theory. Under this scenario, the founder of the startup decides to sell some stake in order to raise some money. Now, the founder is quite experienced, well known in the market for his earlier unicorns and the market is somewhat confident in him. So investors show interest. The founder lets out a word about his startup and the objective behind raising money and his vision etc. This news flows out and reaches different investors, who then go to their offices and start with their pen-paper to judge the valuation of the firm at which they should invest if any.  Now, let's assume that each succeeding investor gets the news from its predeceasing investor and by talking to some others. For example, investor three would talk to investor two and his (three's) other random friends to form his views about the startup.  Also, before proceeding, it would be beneficial to remember the interesting thing about communication. As you might also remember from some teamwork exercises, as information gets passed on, it might get severely distorted. Anyways just keep this through in your head and now let's proceed.

So, the first investor, say, consider the value of startup as equivalent to the monetary value of work that has already been done, that is, the theories developed and theoretical R&D investments, the team, the infrastructure (office etc) and so on. 

The second investor, say, considers not only the net current assets of the startup (which the first did) but also includes expectations of future earnings. Thanks to economists and statisticians in his team, he estimates the probability that the startup would successfully launch the rocket into space. However, this investor believes the concept of taking humans to Mars is too far to be discounted in the present value and ignores it for the time being.

The third investor goes a step ahead of these two and, say, also considers the case that the rocket gets into mars orbit. So this investors valuation adds onto the valuation of the second investor, the scenario that the rocket reaches mars orbit.

The fourth investor now, say, even considers in the present value the case that the rocket lands on the surface of Mars. So, basically, this investor adds this scenario over and about the third investor's case.

The fifth investor, and the last one (because the audience reading this article is smart enough), builds onto the fourth investor and adds to the valuation, the scenario that humans land on Mars and start living there. So, this investor actually wants to invest which can buy him a piece of land on Mars.

Now, compare these five investors and their respective valuations of the same startup. As discussed, there's need not be an objective answer so subjectivity I would comment on what I feel. However, remember that we have assumed that this example world has only five scenario' or discretizations and these discretizations need not be equally spaced. 

So, the first investor's valuation I feel is conservative. Stock markets usually trade at a premium, at least in a growing country like India. So although there's no complaint on other fronts, but if one desires to invest in good stock at such valuation as calculated by investor one, then one may never get a chance. The second investor's valuation I feel is practically a better one. Given the risk appetite of individuals in the stock market in general  (By general investors I mean middle-class individuals who have relatively stringent loss taking capacity, limited investment horizon and just decent enough capital), I think the value found from this valuation method would be beneficial. The third investor's valuation is slightly on an optimistic side. I won't say it's wrong but might suit some individuals who fulfil the desired investment horizon and risk appetite. However, I don't think this risk-reward ratio at this valuation to be suitable for general investors. The fourth investor, I would say has overvalued the startup. Remember, that in this case there is no scenario in between investor three and fourth cases and despite this bigger jump this is what we have. So, one might argue that this is indeed a bubble and not merely over-valuation and that may be correct. However, specific to this example I feel it to better to evaluate it as an over-valuation and not a bubble because the "excess" required in the case of the bubble is available for the next investor. So, the bubble would be in the case of investor five, possibly an Indian guy (no offence) who is interested in buying property on Mars already. Now, investor four and five both I believe have been somewhat irrational in their calculations but the bubble condition is of excessive valuations. 

The Indian stock market was 12k (nifty) before the pandemic. A year later (as of 16 June), it's 16k. So, studying the market I do feel it's an over-valuation at this time but I do not think it's a bubble. The market may behave two ways I believe, if its rationality increases - firstly, it corrects or secondly, it consolidates at the current level. Since I am optimistic about the Indian economy but at the same time concerned about some issues, I would not be surprised if it consolidates and waits for the important hurdles to clear.