Future bubbles are getting more and more difficult to predict. At least it seems so.
The Federal Reserve in the United States even with their huge regulatory arm and research departments could not forsee the bubble that resulted in the Global Financial Crisis of 2008.
Alan Greenspan and Ben Bernake constantly downplayed the risk of the subprime bubble that eventually led to a full blown global financial crisis. It seems from this scenario that central banks might not be effective as a central agency to forecast risks and bubbles that are likely to form. Even if they are successful, certain events might still crop up along the way which are totally unexpected and not forecasted by these public servants.
A bubble forms when there is over enthusiasm and an appetite for risk that is not commensurate with returns.
As we move into 2010, bubbles are likely to form again. Here are a few bubbles that I can think of which might bring about the next market correction or "crisis".
1. Gold Bubble. Gold has been increasing in price for the past few years. It seems that a gold bubble is likely especially since investors are so positive about the prospects of gold. The US dollar is indeed falling but that ought not to justify the performance of gold. A gold bubble in the making?
2. China Bubble. We have all heard it for so many years. Everyone is so positive over the economic outlook of China. They have achieved double digit growth and their yuan is undervalued. Could there be something lurking under this China growth engine to pull the entire world economy down? Shoddy accounting practices...dubious growth figures...over optimism..you bet!
3. Commodities bubble. We have heard that the price of garlic is going up in China. In 2008, commodities were also hot. Jim Rogers has been championing the rise of commodities. Oil prices have also been going up. Is this the next bubble in the making if investors continue to be so optimistic about commodities.
Bubbles will continue to be a permanent feature in the stock market. Where there is asymmetric information and money earning opportunities that seem unlimited, bubbles will always form. It is impossible for anyone to forecast or predict when or what the next bubble will look like. We can however be aware that bubbles do form and when valuations depart from the normal logic or state of things, we can be certain that something is about to burst.
There is no harm in investing during a bubble. Just make sure you stay nimble and get out before the bubble bursts!
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Hi FF,
ReplyDeleteSorry I beg to differ. There is a LOT of harm in "investing" if you know it's a bubble. That's because you usuallu don't feel like getting out because you are enjoying the party so much, or even if you do wish to get out, you won't get your timing right. Hence, the risk is disproprtionately high compared to the reward.
Read the example of Sir Isaac Newton and the South Sea Bubble. One can learn a lot from that.
Regards.
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius.
ReplyDeleteBut Sir Isaac's talents didn't extend to investing.
He lost a bundle in the South Sea Bubble, explaining later, 'I can calculate the movement of the stars, but not the madness of men.'
If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
If we give up the opportunity to invest during a bubble, we might end up sitting on cash for long periods of time. This is because the market can be irrational for long periods of time.
ReplyDeleteI guess you are right also to say that it is harmful to be investing during a bubble. The problem is many of us (at least speaking for myself) are not aware that there is a bubble in the first place due to irrational exuberance.