Why investment markets always bubble – Forbes Advisor UK


The history of investment bubbles dates back hundreds of years, and with the current dramatic price changes of cryptocurrencies such as Bitcoin and Dogecoin, new chapters are still being written.

But if a genius like 18e The science pioneer of the century Sir Isaac Newton could fall victim to it, modern investors certainly need to be on their guard if they are to spot the telltale characteristics of a bubble and not suffer the same fate.

Here’s what to look for, as well as some salutary stories from the past.

How to spot an investment or a wealth bubble?

“There’s only one safe way … and that’s after the bubble bursts,” suggests Joseph H Davis, chief global economist at investment house Vanguard, in a recent market commentary.

But the essence of a bubble is that, while the rapidly appreciating asset in question may appear overvalued, its price continues to rise. Davis says knowing when he’s peaked is the real challenge, “like anyone who’s tried to breathe a last breath into a balloon and found it can accommodate two or three can relate to himself.”

In other words, investment bubbles are easy to predict, as long as you take a step back.

With their potential for stellar, albeit highly volatile, returns, cryptocurrencies such as Bitcoin and Dogecoin inspire even the most disciplined investors to grab a potentially lucrative Fear of Missing (FOMO) stock – a recognized key component of investing. bubble process. But what are the other telltale signs?

Russ Mold of investment broker AJ Bell says, “One way to judge whether something is a bubble or not is to follow the classic bubble cycle described by Charles P Kindleberger in his masterful story of financial chaos, Manias, panics and crashes, ”Before discussing several key phases:

  1. The places to start are cheap credit and the prospect of a fabulous new investment opportunity that offers the prospect of big payouts – everything from tulip bulbs and railroads to Japanese properties and tech stocks. , will do if the mood is good.
  2. Initial price hikes then grab the attention of newcomers, as FOMO begins to rally
  3. Profits from investments are put into orbit and new money is attracted, often in the form of borrowed money
  4. Copiers and imitators appear and more credit becomes available as asset prices continue to rise
  5. The trouble begins. Insiders are starting to lock in their profits by selling at high prices. This leaves the last investors to hold the bag. Prices are initially correct but then rally as loyal supporters “buy on lows”
  6. A new offering goes awry, and the queue of stock quotes and management teams looking to sell their stock grows. Supply begins to exceed demand and asset prices fail to reach their previous highs.
  7. Then comes a scandal, in the form of fraud or bankruptcy. Investors Realize They’ve Been Fooled And Their Money Is Gone
  8. Fear and revulsion replace greed, asset prices plummet as investors scramble to cut losses and the blame game begins.

The most famous investment bubbles in history

Tulip mania

Tulip mania peaked in the Netherlands in 1637 and is often cited as the first financial bubble to have a far-reaching impact. The seeds of disaster had been sown in previous years – a period known as the Dutch Golden Age due to the country’s preeminent international position and commercial reputation.

Tulips, native to the Middle East, had acquired a luxurious and unmissable status, driving up the price of bulbs to the point where specialized versions took on the same value as entire properties. The individuals who speculated and took part in the buying and trading of tulips became impoverished overnight due to an unsustainable situation.

Contracts that had been made on future crops became worthless because of the oversupply. Once buyers were convinced that the tulips were too expensive, their prices plummeted. Amid all the frenzy, few had paused to think about the lack of intrinsic value that flowers could actually demonstrate.

South Sea Company

Sir Isaac’s bubble woes arose because he staked a fortune on the success of the South Sea Company only to lose heavily financially in the ensuing crash in 1720.

“I can calculate the movement of stars, but not the madness of men,” complained the scientific colossus.

The background of the South Sea Bubble is heinous, because it is rooted in the slave trade. The Treaty of Utrecht of 1713 granted Britain the right to supply slaves, and the South Sea Company was formed to send slave labor to Spanish plantations in Central and South America.

The South Sea Company bought the contract from the British government for £ 9,500,000 (about £ 2 billion in today’s money), a colossal sum equivalent to a large chunk of Britain’s national debt. The price was high as the intention was to secure even more lucrative trade rights with South America once Britain became an established player in the slave trade.

The assumption was that the profits from the slave trade would be huge, which turned out not to be, and the South Sea Company went bankrupt in 1720.

Speculators, including scientist Newton and author Jonathan Swift, have been financially burned after paying inflated prices for the stock just to bring the company to its dramatic collapse.

Japanese asset prices

Japan’s asset price bubble peaked at the end of 1989 after being preceded by a period in which the country’s property prices and stock markets had swelled sharply.

At one point, the land under the Tokyo Imperial Palace was valued more than the state of California as a whole. The whole episode in Japan was characterized by rapid acceleration in asset prices, overheated economic activity, as well as unchecked money supply and credit expansion.

The story is best illustrated by examining the performance of the country’s benchmark Nikkei stock index. At the end of December 1989, the Nikkei reached a record high of almost 39,000, an increase of 900% over the previous 15 years. During 1989 the index had risen 30% on its own, but by the end of the following year it had fallen dramatically, losing around £ 1.5 trillion in value.

In 2003, it fell to 8,000, and when the global crisis hit five years later, it fell to 7,600.

Japan’s economic collapse has lasting consequences, and the Nikkei has never failed to reach its previous highs thereafter. Today it is trading around the 28,500 mark.

Dot.com boom to bust

The dot.com bubble lasted from 1995 to 2000, coinciding with the Internet revolution, which helped create a wave of fledgling businesses, especially in the United States – the dot.coms – each seeking to capitalize and profit. of the future of online commerce.

Expectations, however, were unrealistic. For every successful business there were dozens of failures, usually those with unsustainable business models unable to make any money.

In the rush to cash in on the internet boom, investors ignored the fundamentals of stock investing at a time when even the top performing players were trading overvalued valuations.

In the five years leading up to 2000, the tech-dominated US Nasdaq market grew from around 1,000 to over 5,000. However, companies began to go bankrupt and the bubble burst, the Nasdaq then falling below 2,000 in 2002.

Cryptocurrencies – a bubble about to burst?

Recent actions by Chinese authorities (banning transactions) and Tesla boss Elon Musk (who cited damaging environmental issues related to computer “mining”) have contributed to a 45% drop in the price of the cryptocurrency Bitcoin since it briefly hit $ 64,000 in April this year.

This has sparked concern from commentators wondering if cryptocurrencies in general, including Bitcoin rivals such as Ethereum and Dogecoin, are contributing to the next financial bubble.

In line with the bubbles of the past, the ingredients are there: a potential to earn money, plus a willing audience.

One of the big differentiators between the bubbles described above and what is happening in the cryptocurrency realm right now is that none of the previous bubbles (not even the dot.com version) took place in the world. age of social media. The word is circulating rapidly in the 21st century, accelerating both actions and reactions.

Cryptocurrencies have certainly seen a roller coaster comeback in recent months. On the one hand, fans think they are the future of digital money. But critics accuse cryptocurrencies of being vehicles of speculation at best and Ponzi schemes at worst. In other words, fraudulent investment scams.

And you can add to the mix the sheer amount of energy involved in keeping the cryptocurrency business going – the problem that was before Musk.

Chain reaction

Given that it’s hard to spot a financial bubble until it finally bursts, it’s probably too early to tell if cryptocurrencies definitely fit the description of one.

There is also the question of the useful by-product induced by the introduction of cryptocurrencies, namely blockchain transactions. These are currently of interest to both financial institutions and central banks.

Neither Tulip Mania nor South Sea Bubble could boast of such a potentially useful tech spin-off. Perhaps it is this consideration that will further prevent the bubble characteristics of cryptocurrencies from fully bursting.


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