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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What's been said:

Discussions found on the web:
  1. praktike commented on Apr 11

    Hmmm … a bubble in bubbles … surely there’s a way to make money from this phenomenon.

  2. Barry Ritholtz commented on Apr 11

    The way to make money is to recognize that we have been in a reinflation mode, doubling hte Nasdaq from its lows.

    I still find a lot of post-bubble complacency in the Markets — perhaps thats where you can make some dough!

  3. CalculatedRisk commented on Apr 11

    Great new look!

    A bubble is usually defined by two characteristcs: 1) overvaluation based on fundamentals and 2) by the level of speculation. I doubt most of the “bubbles” that are being discussed these days meet those criteria. I think housing does, but not oil, bonds or even China.

    And housing is a different bubble than the Nasdaq. Housing typically deflates slowly after a speculative peak due to market frictions. In that sense, I can understand why some people wouldn’t call housing a bubble.

    Right now I think housing is especially important since the boom has played a major role in the recovery (I’m including the mortgage equity withdrawal portion of the housing boom). Just a slowdown in housing could impact the entire economy.

    Once again, great site! And great new look.
    Best Regards.

  4. anne commented on Apr 11

    Perfect! Thank you :)

  5. Glenn commented on Apr 11

    OK, I’ll bite. What is the difference between a 25% drop in an asset leveraged 80-100% (real estate) and an 80% drop in an asset leveraged 0-50% (tech stocks)?

  6. dave commented on Apr 12

    As long as we are obsessed with spotting the bubble, there is no bubble. Everyone saw the dotcom bubble, but it kept growing and didn’t reach its top until everyone seemed to acknowledge “it really was different this time.” When serious executives begin leaving their jobs to get a real-estate license or run a REIT, then we’ll know it’s over. Recall the CFO of Citigroup leaving to join I also recall an article with Jack Welch seemingly mocking a couple of his executives for leaving GE to go “deliver groceries.” (

    A lot of people are making good money in real estate, but there are plenty of people not making money. As long as there are people waiting to get in, it’s unlikely to end all that bad. Over-leveraged people will get wiped out but that does not describe most households making monthly mortgage payments and receiving annual salary increases.

    Also, housing has real value and when the speculators lose, young families will be standing in line to purchase the newly-affordable merchandise. Top-ticking the California housing market with an $850,000 interest-only loan is not a good idea, but it is not going to lose value the way Commerce One, Worldcom, Enron and other paper assets that went so bad.

    Something else to consider is the relatively low productivity improvements home-building has seen compared to businesses that have leveraged automation and technology. The economy has grown so much over the past two decades. But has house-building capacity scaled to meet the higher demand? Perhaps there is a supply problem with housing (can’t outsource that work to China or India). Screw guns and pneumatic tools are a big improvement, but much of the work still requires a skilled craftsman’s time.

    I agree higher interest rates will wash out marginal home buyers but I’m not certain the prices are going to collapse that much. Because as soon as the prices decreases enough to offset the higher interest rates, the marginal buyer will be back in the market.

  7. dsquared commented on Apr 12

    Housing typically deflates slowly after a speculative peak due to market frictions.

    Would like to see some evidence of this. I lived through a housing bust (UK 1989-92) and it seemed pretty quick at the time. Got to separate a slow decline in the average transaction price (represented by a usually non-investable index) from what actually happened to the prices of the underlying houses. Those “market frictions” are what we call *illiquidity*; if you put your hosue on the market at £300K and the estate agent calls you next week and tells you it won’t sell above £200K, then that’s pretty fast.

  8. bhaim commented on Apr 12

    The first edition of Yale economist Robert Shiller’s book “Irrational Exuberance” rolled off the printing presses in March 2000, at the peak of the dot-com boom. In that edition, Shiller predicted the collapse of the stock market, which did happen one month after the book was published.

    Now Shiller’s updated “Irrational Exuberance” to take aim at what he sees as a groaning bubble in the American real estate market. Get ready for a crash, he warns. Prices in red-hot markets like New York, Boston and San Diego could fall as much as 40 percent within the next few years, says Shiller. The only thing keeping prices so high is the expectation that they will go even higher, Shiller says, but there is a limit and we are there.

  9. dave commented on Apr 12


    A 25% drop in a home’s value will not generate a margin call so long as the monthly payments are timely delivered.

    Speculators will see no difference in the two asset classes, but my sense is most mortgage holders are not leveraged for the speculative nature of the asset. Quite the opposite when it comes to the stock market.

  10. _o_________ ___ _______ commented on Aug 19

    More Housing Bubble T-Shirts

    Barry at The
    Big Picture points out another popular housing bubble t-shirt, a
    parody of Mr.

    Barry thinks that the fact that because there are declarations of the bubble everywhere, that it is must not be a bubble.

    I find that somewhat ir

  11. Real Estate Investor commented on Mar 20

    Bubble or not is a different issue in my opinion and the priority is to see how long can we survive in this so called bubble.Real Estate investment is not only the best option to invest but it is also the best option keeping the tax criteria in mind.The post was well written and it clearly shows the command that the blogger has on this subject.

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