The Crash Course - Chris Martenson [46]
Bubble Characteristics
History is littered with the wreckage of financial bubbles involving a surprising diversity of assets, with more recent examples involving railroads, swamp land, Internet stocks, and housing. The asset itself, whether land or bulbs or pieces of paper, is irrelevant. What matters is having the right story—usually involving massive riches soon to come—a credulous mob, short-sighted (or greedy) lenders, and an ample supply of credit. If any one of these things is missing, no bubble will result.
What’s interesting is that nearly every bubble shares the same common, and therefore predictable, features. Bubbles are self-reinforcing, meaning that on the way up, higher prices become the justification for higher prices. Once the illusion is lifted, the game is suddenly and permanently over, but not instantly, as it takes time for reality to set in. This lends a rough symmetry to the price charts of assets as they rise and then fall over time. In the 1920s a bubble developed in U.S. stocks, and its bursting still echoes even today, because it was immediately followed by the Great Depression.
Figure 11.1 demonstrates two important traits about bubbles. Note that the amount of time it took the Dow Jones to run up to its price peak in 1929 is roughly the same amount of time that it took for prices to fall back to their starting levels. The first characteristic of bubbles is their rough symmetry. They first rise, and then they fall, but not instantly, revealing that bubbles take time to develop and then to unwind. First the psychology has to be built into a frenzy, a mob has to be formed, and then it has to be slowly dismantled, one person at a time. However, despite this apparent symmetry, bubbles usually burst just a little bit faster than they develop.
Figure 11.1 Dow Jones Industrial Average, 1922–1935
Source: Yahoo! Finance.
The second characteristic of bubbles that we see reflected in Figure 11.1 is that asset prices will usually fully retrace to their starting point, if not just a little bit further. Whatever the starting point was for the asset prices in question is a reasonable place to suspect they’ll eventually end up at some point in the future.
To reinforce this point, Figure 11.2 shows the stock price of General Motors (in the black line) between the years 1912 and 1922 and Intel (in the shaded line) between 1992 and 2002, periods during which both stocks were swept up in bubbles. Here we might also note that the price data looks very similar for both stocks, despite the fact that one was a car company in the 1920s and the other was a high-tech chip manufacturer trading some 80 years later. Again we might note that they share the two characteristics of bubbles that we’ve already discussed: a rough symmetry in both time and price. They crescendo, then crash, and end up right where they began.
Figure 11.2 Stock Prices: GM and Intel
Source: Yahoo! Finance.
The fact that bubbles display the same price behaviors over the centuries and decades tells us that they’re not artifacts of particular financial arrangements, cultures, or legal systems. Instead, the constant factor is people. Bubbles do not develop as a condition of poor financial engineering or specific financial laws and regulations that happen to be present, nor because of particular cultural practices, but as the by-product of greed, hope, and excessive credit. Wherever these circumstances exist, bubbles will eventually develop, which is why investors should hold onto their wallets whenever they spot such conditions.
Asset bubbles, therefore, aren’t so much financial phenomena upon which we can conduct meaningful financial post mortems as they are sociological