They are the investment phenomenon which makes a person’s wildest financial dreams come true and then instantly shatters them. Investment “bubbles” have been inflating and bursting for hundreds of years.
The wild ride of the gold price and the value of digital currency group Bitcoin over the last few weeks is a timely reminder that while asset price bubbles can be fun on the ride up, you don’t want to be caught in the inevitable bust.
The key is identifying when your investment is becoming a bubble rather than just delivering strong asset value growth. It can be a fine line and bubble identification is often done in hindsight. But we have plenty of bubble history to draw on for guidance.
I’m old enough to remember the gold bubble of the late ’70s and early ’80s, when the precious metal dropped 57 per cent overnight on Valentine’s Day 1980.
Since then, we’ve seen the Japanese “Take Over The World” bubble in the 1980s, the Asian currency bubble of the mid‑90s, the dot‑com bubble of the late ’90s, and the global easy‑credit and housing bubble of the early 2000s, which culminated in the Global Financial Crisis.
But it seems even painful crashes haven’t stopped buyers from driving other assets into “bubble land,” where prices are well above what good old-fashioned investment fundamentals like supply and demand would dictate.
Inevitably, the investment cheerleaders in bubbles start using phrases like, “traditional investment fundamentals don’t apply in this case because …,” or “it’s different this time because…,” or “there are no limits because we’re changing the paradigm by….”
Whenever you start hearing this type of language you should start to be concerned.
Been there, done that
Investment history tells us that every asset runs in a cycle, and prices generally gravitate back to their historic averages if the pendulum swings too far in either direction.
Many experts warn we’re more exposed to bubbles than ever, and they’re inflating and deflating faster. Technology and products like Exchange Traded Funds (ETFs) make it easy for larger amounts of money to swamp an investment, driving prices up rapidly, then be pulled out just as quickly to cause a sharp burst.
The investor strategy seems pretty simple: See a bubble, walk away.
The problem is, it’s all but impossible to spot a bubble before it collapses. Experts also seldom agree about whether a given investment fits the bill. One analyst’s catastrophe-in-the-making is another’s new traditional “opportunity”.
So, to try and help avoid being caught in an investment bubble, here are some of the tell-tale bubble scenarios I’ve come across over the years and which sound a warning:
How to spot a bubble red flag
A little too ‘revolutionary’
A stock based on a process or technology that claims a revolutionary, unlimited path to growth is exactly the kind of hype that fuelled the dot-com bubble.
Excess cash and few opportunities
When cash is abundant and investment options are limited, it leads to people buying or investing in anything available. This is often the basis of our housing booms.
Too tricky to understand
If an idea is so complex that it can’t be fully explained to investors, that’s a warning sign. Remember Firepower and its “pill” to drop into the petrol tank for better efficiency?
A lemming phenomenon
This is when the crowd blindly follows the leader — even the gardener has a tip! Think of the Nickel/Poseidon boom of the ’70s, a pattern that seems to repeat on the share market every 5–6 years.
“New paradigm” claims
New fundamental levels are sanctioned by supposed experts claiming, “We are in a new paradigm!”
Relaxed lending practices
Financial institutions loosen lending rules. Easy money flows like water to anything or anyone with a new idea.
Cult figures and media hype
Influential personalities emerge to champion the new paradigm. The media celebrates the “greed is good” gurus and their lavish lifestyles.
Rationalisations, but no selling
Everyone has a reason why it can’t continue – yet nobody sells. Profits are held, new buyers vanish, and the market stalls.
Smart investing tips
As well as learning how to spot a potential bubble, you can also protect your money with these investment fundamentals:
Invest in quality assets.
- Understand what the investment actually does.
- Take profits on the way up and bank them.
- Maintain balance in your portfolio.
- Understand where you are in the investment cycle.
Remember too, it is better to make a little less profit by selling too soon than to take the greater risk of overstaying the market in a stock which is overpriced.
Investment bubbles happen, so be aware, cautious and agile.
