Understanding the chemistry that fuels stock market bubbles is a difficult and complex study that even risk-averse professionals have a hard time understanding. So I wondered, is there any chance that we as first-time retail investors or even some seasoned retail investors can anticipate or predict, even with the most modest certainty, when and how these investment and investment bubbles will burst? assets in the future?
I think the answer is no, not really. However, I think that with just a little diligent effort in analyzing the bubble patterns above, maybe we can at least avoid them. Let’s be honest; Not only do bubbles exist and contributed almost first-hand to the Great Recession and financial crisis of 2008, but the phenomenon will continue and is almost certain to occur again, perhaps sooner rather than later.
Let’s start by looking at some of the biggest hits in US history, and use the knowledge and lessons learned to apply it to our search for the current stock or asset bubble.
Two bubbles for the price of one
Hands down, the most devastating, and perhaps until recently the most infamous, stock market crash of all time occurred between September and November 1929, when the DOW plunged from roughly 380 to 200 points, slashing roughly 50%.
But what is “conveniently forgotten,” says Michael Bordo, professor of economics and director of the Center for Monetary and Financial History at Rutgers University, in a presentation called the CFR Symposium on a Second Look at the Great Depression and the New Deal. ” is that during the following months, from early November 1929 to mid-April 1930, the Dow Jones average rose again to almost 300 points. “
That seems fine and elegant, until the newly created US Federal Reserve decided to step out of God’s standard while the rest of the public was still knee-deep in a love affair with the precious metal. Many academics and economists studying the facts will argue that the result was a global boom in demand and a contraction in the supply of gold, a lack of banking liquidity, and the Great Depression, during which the Dow Jones plunged 42 points in July 1932.
One lesson I would like to learn from here is that before, during and after the catastrophic financial events of the 1930s, gold has been considered a safe and hard asset to invest in during the economic crisis.
The smartest bubble of all time
What do the words “Pets.com” mean to you? As a first-time investor, you are likely to go blank. As a hindsight seasoned retail investor, that cute naive domain name might have served as the most important lesson the irritation has ever had to learn.
While the effects of the dot-com bubble burst weren’t necessarily powerful enough to bring the entire economy to its knees, after hitting highs of around 5,000, more than double its valuation from just a year earlier, the The technology-linked Nasdaq Composite Index lost more than 60% and $ 5 trillion in the market value of publicly traded companies between 2000 and 2003 when the technology bubble burst and deflated.
The lesson I would like to learn from the dot-com bubble is a reminder of the definition of a stock market bubble itself, which according to Wikipeda.org is a “self-perpetuating rise or boom in the prices of shares of a particular industry. “
Soaking up the shock of the next pop
I think we can use these two valuable lessons and combine them to formulate our own personal “bubble prep plans” for our individual investment goals. Here’s how: Identify where you think the next bubble could form, choose specific price points to enter. and always be ready to let it go.
Gold is making big headlines again in print, media, and the Web, and for the same classic and recognizable reasons listed above: The price of the ubiquitous metal is hitting new highs (although adjusted for inflation, some They’ll argue that gold hasn’t actually hit new highs yet, but that’s a completely different article.)
We don’t have to look far to identify the parallels between the historical collapse detailed above and the potential for a collapse in gold today. The panic occurred in the late 1920s and early 1930s when financial chaos settled in the economy, causing a nasty recession, unemployment, and investor panic in much the same way as the 2008 financial panic. comparison is almost perfect.
Next, government officials, lawmakers, and the Fed from both eras invested billions of dollars in newly created laws that were designed to stimulate and fuel the economy’s growth. Both feds also enacted fiscal monetary policies that included artificially low interest rates.
What happened next is again predictable for both eras, as investors piled on the hard and safe asset that is gold, sending prices skyrocketing amid worries and worries of inflation, a weakened dollar and continued turmoil in the stock market.
Now consider again the definition of a bubble as a self-perpetuating rise in asset prices. First of all, inflation is not really a big concern; in fact, the Federal Open Market Committee has recently been talking about deflation becoming more worrisome than inflation, which if true could be a fatal blow to gold prices.
Second, the dollar is not as weak as it was before entering the most recent crisis. Unfortunately, the euro was hit this year when Greece and a handful of other euro zone countries admitted that fiscal debt had become too much to bear, in some cases more than 100% of GDP, resulting in a massive bailout for the country and strengthening. of about 11% in US dollars versus our foreign currency counterpart.
Lastly, the turmoil in the stock market may have finally stabilized. It’s a bold claim, I know; But I’m making this prediction based on how far we’ve come since the start of the financial market fallout in 2008 and the subsequent rally in March 2009 to today. Despite some confidence-crushing stumbles such as the Flash Crash in early May and continued volatility across all major indices, September 2010 has delivered significant and solid gains almost across the board.
I don’t think that we as first time investors or even seasoned retail investors can correctly predict or identify and avoid stock market bubbles, but I think it is never too early to start thinking about the next burst. After all, if I’m wrong, the only thing I lose is some credibility or confidence in my investment skills, which is probably a good thing from time to time. However, if I am correct, there is no limit to how much I can earn or save.