Sunday, July 28, 2013

Economic bubbles

According to André Kostolany, stock markets are like a man walking with his dog. They both follow the same path, but, while the man is walking slowly, his dog is jumping around back and forth. Sometimes man is ahead; he will wait for the dog and in other occasions when the dog is ahead and the dog will wait. The man represents the economy, and the dog stock markets.

Question is why this happens. How come that wisest experts in biggest investment banks do not agree them all if stocks will go up or down by just studying numbers.., even most often, when most agree, they are wrong..

In a previous post we showed an example of investment based in company public/published data, as, normally, any fundamental investor would do, but, what if those data are not totally true, or if there is most updated information, internal problems, new legal regulations, etc..., that is not known yet...

All these uncertainties may be reasons for the dog to go forth and back, but, as humans, there is an even most important reason human psychology. And this, actually, has not changed in last 8000 years...

In stock market bubbles, human nature comes in and mucks up elegant economic theories.

So, it is important to be aware when a bubble ongoing, to avoid get trapped, and, if you are smart enough, to make money out of it.

Stock market bubbles are as old as stock markets. Probably there were bubbles in ancient Egypt based on wheat price, or on real state in Rome, but one of the first documented ones was the Tulip mania, where prices of a single tulip bulb was higher than the price of a mansion in Holland.

Some years later, we can find the South Sea Bubble, where South Sea Company shares went up next to £ 1000, to drop under £ 70 in few weeks.

Even people as smart as Isaac Newton lost lot of money in this bubble..

We could ennumerate many others, but just as example, lets mention a just a few more, the pre 1929 stocks bubble:

The known dot com bubble, year 2000..

The following real state building, pushed but low interest rates and subprime mortgages, to recover from previous bubble...

The post 2008 crisis gold bubble, (many people won't agree on calling this bubble yet, denial phase, see below).

And just a few months ago, Bitcoin bubble, last closing price, Friday July 26th was $94.72,

So, have you noticed the pattern, yes, all of them look alike.., just now things happen faster and faster..., and main impulse to bubble is human psychology, here we see the known phases in every bubble...:

In fact, using some common sense and making numbers, bubbles can be avoided, even they can be used to get some profit out of them but, be aware, it is not as simple as it seems, people as smart as Newton were caught by crowd psychology, and it is hard to listen to your neighbour saying he is making money in (dot com, gold, real state, tulips, etc..) and you are not...

Which is next, shale gas,  3D printing, self driven cars, China real state, student loans in USA, art, wood.., don't get trapped, if something had a bubble before, history always repeats.