Identifying bubbles

Typical characteristics of a bubble:

  • Rapidly rising prices
  • High expectations for continuing rapid rise
  • Overvaluation compared to historical averages
  • Overvaluation compared to reasonable levels
  • Several years into an economic upswing
  • Some underlying reason or reasons for higher prices
  • A new element, e.g. technology for stocks or immigration for housing
  • Subjective “paradigm shift”
  • New investors drawn in
  • New entrepreneurs in the area
  • Considerable popular and media interest
  • Major rise in lending
  • Increase in indebtedness
  • New lenders or lending policies
  • Consumer price inflation often subdues (so central banks relaxed)
  • Relaxed monetary policy
  • Falling household savings rate
  • A strong exchange rate

 

Source: “When Bubbles Burst – Surviving the financial fallout” by John P. Calverley

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11 times in 18 months …

In September 1998, Kothari Pioneer launched a new scheme – a sector fund, Kothari Pioneer Infotech Fund. By February 2000, i.e. within 18 months, the NAV had multiplied close to 11 times.

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Are financial bubbles bad?

Many discussions surrounding financial bubbles conclude with suggesting that financial bubbles are a bad thing. However, here is one blog post that considers otherwise.

I tend to agree with the thoughts. A bubble per se is not bad – many investors lose money in the aftermath of a bubble, but bubbles also shake the established players and bring in new heroes. Without the bubbles, one would not have seen some of the major players of today.

#RidingTheRollerCoaster – 215

Hindsight is 20:20

Whether it is euphoria or panic, it is often only in hindsight that we can clearly see what it was. At the time, it often appears to be the truth. Every action appears to be rational and based on some fundamental factors.

#RidingTheRollerCoaster – 149

When liquidity is sucked out …

Charles Prince, the then Chairman of Citibank made an infamous statement during the heat of 2007 frenzy, “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

He was only stating the old proverb, “Make hay while the sun shines.” in different words.

The problem in all such situations is it is difficult to figure out in advance when the music would stop. And by the time it does, there is a mad scramble at the exit door.

#RidingTheRollerCoaster – 128

This can’t happen to me

Even when the risk is clear and present, common investors and experts alike often believe in their ability to get out unscathed.

“This cannot happen to me.” – is a common belief.

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Rise and fall are inevitable

Rises and falls in market prices are inevitable. They are part of the nature of the open markets, wherein a large number of people can come and transact, based on their perceptions and opinions.

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