By the sounds of it, everyone is perfectly capable of spotting asset bubbles. But if they are so obvious, why do we keep getting caught in them when they pop?
James Bullard, president of the Federal Reserve Bank of St. Louis and a member of the Federal Open Market Committee, which sets interest rates and approves stimulus measures, believes that bubbles are as easy to spot as a puffy cloud in a blue sky.
In a recent interview with Bloomberg Television, he assured us that equity prices are "fairly" valued right now, in contrast to the "outlandish" prices for technology stocks in the 1990s or house prices in the 2000s.
"Both of those bubbles were obvious at the time," he said. "People were talking about them."
He could have also mentioned gold in 2011 or perhaps even Potash Corp. of Saskatchewan Inc. in 2008 – two recent examples where prices went vertical amid drooling enthusiasm, and then fell sharply.
The thing is, we are always facing one bubble or another – and they are notoriously difficult to spot, especially at their most inflated point, until after they burst.
However, far from giving up and surrendering yourself to the whims of the market, there are a couple of things you can do to protect yourself from disaster.
First, forget about waiting for a signal from the experts (and that includes central bankers) because you are not likely to receive one in time.
Alan Greenspan, the former chairman of the Federal Reserve, is widely credited with warning investors of "irrational exuberance" in stocks during the runup to the disastrous tech bubble. But the line came more than three years before the market top, leaving you to ponder a subsequent 280-per-cent gain in the Nasdaq.
More importantly, it's hard to see Mr. Greenspan's line as a warning. It was a question, essentially asking: When does irrational exuberance lead to corrections? He didn't provide an answer, other than to say that central banks don't care about burst bubbles until they rattle through the economy.
Mr. Greenspan has since been labelled a notorious bubble-blower – but perhaps he was just doing his job. Larry Summers, the economist, former Treasury secretary and President Barack Obama's first choice for Fed chairman, suggested at an International Monetary Fund conference last week that the U.S. economy might need bubbles to achieve full employment, just as it needed them in the 1990s and last decade.
If that's the case, then you had better make yourself responsible for spotting bubbles and avoiding them at their peak.
It requires a talent for walking away when the stock market is at its most attractive – when everyone is talking about stocks and scoring big returns, when new stocks double in their first day of trading and when major indexes hit successive record highs.
Sound familiar? Okay, Mr. Bullard is probably right: It is hard to see pervasive signs of overvaluation in today's market, when the S&P 500 trades at a not-unreasonable 17 times earnings and there are few signs that investors are fully immersed in stocks.
But with the bull market approaching its fifth anniversary without experiencing more than a 10-per-cent correction in more than two years, it is healthy to feel a twinge of skepticism that the good times can last.
If we are not in a bubble now, we are likely headed into one. And its path will resemble the others: lots of enthusiasm on the way up, denial of the existence of a bubble at the top – and reflections afterward that the bubble was so, so obvious.