Bubbles/Booms and Crashes part 1

 The section is intended to describe larger-scale bubbles / booms and collapses, not individual stocks, bonds, or other investment products. Some of the lessons also apply to individual investing vehicles. I use a bubble when I talk separately about the insane price of an asset class. The boom describes the general euphoric economic conditions.

Almost all bubbles and booms contain too much cheap money, positive emotions, too little fear of losses, moral hazard, an abundance of amateur investors into the market, an euphoric consumer sentiment, a sense of the new age, and positive political factors. Before long, the bubbles burst. This often involves shrinking money supply, negative emotional storms, excessive fear of loss, and the negative effects of political factors. Explaining bubbles, booms, and collapses by individual factors or patterns is absurd but annoyingly common.

Bubbles and booms are causing insanely high prices for different asset classes. Prices can be so high that no one can imagine them. For example, Japanese real estate prices rose tenfold in the 1980s and stock prices 6-7fold at the same time. Common to the booms and bubbles is the increased peak prices much higher than previously expected. Yield expectations become mathematically almost impossible. The insanity can be outlined by calculating what kind of returns should be obtained at current prices, even over the next couple of decades. When you start talking about double-digit percentages that don’t start with one, it’s certain that a boom or bubble won’t last.

Bubbles and booms are about excessive demand compared to supply. In crashes, supply is excessive compared to demand. Price bubbles are more likely to occur in assets where supply is limited or demand is high. One of the former is Bitcoin and one of the latter is commodities. Bubbles, booms and crashes are self-reinforcing events. Both are also impossibilities for mainstream economists. They are explained by external shocks. Bubbles, booms and collapses are not uncommon. There have been many bubbles and booms in the last three decades: the Japanese real estate bubble, the Asian economic boom, the dot-com bubble, the U.S. real estate bubble, and the Chinese real estate bubble.

In the current situation, in January 2022, many can assume that they will also see inflated bond prices or a tech bubble. Bubbles and booms, to my knowledge, have not been mathematically defined by anyone. They have no precise definitions. Their prices are at unsustainable levels, which will fall drastically in the end, causing prices to collapse and major economic damage. This section looks at the extensive bubbles and booms that have a strong impact on the economy and their characteristics. I will briefly review the special features of stock and real estate bubbles later.

Independent thinking is a golden characteristic for the investor. During bubbles, booms and crashes, it is more important. During them, there are more empty suits who come up with at least one credible reason for nonsensical prices or the “end of the world” like “we live in a time of low interest rates.” At the extremes of cycles, mass hysteria causes large losses for investors. At other times, watching large crowds is less dangerous. Medium returns are reasonable and there are no major upheavals threatening investor assets. You must be able to identify mass hysteria by yourself. The content of the book helps with that, but it does not remove the importance of independent thinking.