Posts filed under “Psychology”

The Bubble in Bubbles

There’s a notorious old saying:

Generals always fight the
previous war

It applies just as much to investing as it does to warfare. Human
nature prefers the familiar to the unknown, the comfortable to the strange.
Generals study the tactics of prior enemies, while Investors look at market
history, seasonal factors and charts to help them come to grip with the
unknowable future.

The same can be said for pundits: They have a tendency to be
overly influenced by what has come before. Indeed, it is Human nature to be
unduly influenced by the most recent data in a
series. I suspect this is especially true with those who, last time around,
missed the Great Bubble: the / telecom / tech stock bubble of the

Despite this, or perhaps because of it, we currently find
ourselves now in a Bull market for Bubbles. There is the housing Bubble,
the oil
Bubble, the interest rate Bubble.
I have read about the import Bubble, the China bubble, the current account
deficit Bubble, and the credit debt Bubble.

The Fed does econometric research
to see if we can detect Asset Price Bubbles in advance. Several writers believe
China is one great big Bubble – if not the nation,
than China Net stocks.
Some books advise us how to survive Bubbles,
while others warn us of the impending Bubble in US foreign policy.
From Australia, we learn there is even a Bubble in economic blogs.

In short, we have a Bubble in Bubbles.

Yet if we give careful consideration to the nature of
bubbles, we see that most of these are not bubbles at all. They may be assets
whose prices are extended – but being overpriced is not the same as being a
Bubble. Rapid price appreciation increases the chance of a significant price
retracement in the future. But all Bubbles? Hardly.

Bubbles have common characteristics. There is a tendency for
prices to move in a parabolic fashion, then the public gets passionately
involved. There are ongoing visible rationalizations as to why its different
this time – i.e., why valuations are actually reasonable and why the trend will
continue far into the future. Lastly, we see valuations that detach from
economic reality. But a 25% drop in Home prices is very different from an 80%
tech stock collapse.

We advise not taking the wrong lesson from Bubbles past.
Instead, Investors should be flexible and adaptable when confronting with the
unknown. Reliving the past can be a costly error in the markets – and a fatal
one during War.


UPDATE April 18, 2005 10:49pm

Both Business Week and the Los Angeles TImes picked this piece up . . .


A Bubble in Bubbles?
Amey Stone
Business Week 04/11/2005

In 2005, a Rash of Possible Bubbles
Tom Petruno: Market Beat
L.A. TImes, April 17, 2005,1,2296415.column?coll=la-headlines-business-invest




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