I’m getting sick of the word ‘bubble’

Are US and UK equities really ‘in a bubble’? I don’t see the evidence for it myself. But it’s a phrase that’s taking up a lot of space in the financial pages. And I have to admit it’s starting to get me a bit annoyed.

Why does the word bubble bring in 72,000 results in Google News today? Why is the financial press so quick to write off recent growth?

I think that they find the idea of a bubble alluring. It fits with a certain type of investing outlook.

And it’s worth noting that until recently, the word bubble didn’t have a life of its own… It was always partnered with speculative to give it meaning. A speculative bubble describes a market that had been puffed up to levels far beyond what can be justified by the fundamentals. It speaks just as loudly about the way investors are behaving as it does about how far prices have risen.

To find a good example of a speculative bubble we don’t have to look further than the US Nasdaq index at the height of the dotcom boom. It went from 1,420 to 5,000 in just 18 months. This 250% rise definitely was a bubble. Some companies with barely any sales or assets rose to absurd valuations.

Investors piled in because tech shares were going up fast, and they found it impossible to resist the temptation. The rush of a few easy profits led people in deeper and deeper, until the whole thing collapsed.

Always remember – once pricked, a speculative bubble doesn’t just gently deflate. It pops. There’s nothing inside it except hot air and hope, so once sentiment turns, prices plunge. The Nasdaq fell a breathtaking 78% in the 30 months after its spell was broken.

That’s a recent example, but speculative bubbles are as old as investment itself. The South Sea Bubble was the original stock market example. Starting as a scheme to manage British national debt in 1711, it morphed into speculative mania. In 1720, South Sea Company shares rose from £100 to £1,000… before collapsing back to £100.

People bought them for no other reason than because they were going up. This type of disregard for fundamental value, in favour of manic speculation, is an essential element of a bubble.

Spotting a bubble in the making

In the property market, speculative bubbles inflate when buyers put down deposits to buy new apartments off-plan. They have no intention of living in the flats, they just want to trade them on when, in a few months, their value has gone up.

We see them too when people move house, not because they need a bigger place to live in, but to increase their exposure to the soaring property market. Or when they do something really off-the-wall, like buying a holiday home in Bulgaria.

Yes, I know house prices in central London have gone through the roof. But are people piling in with lots of debt in the expectation of making a quick buck?

My impression is that there is just as much angst as euphoria over these rising prices. And if there really is a speculative bubble in houses, it has yet to reach my corner of the country where ‘for sale’ boards can stay up for an awfully long time indeed.

Why this word matters

I suppose our willingness to spot bubbles everywhere is part of the modern world of hype. But for someone like me, there’s a big reason why people misusing words like ‘bubble’ is important. An investor can often make money by going against the conventional wisdom. So it’s always a good idea to listen to what the consensus is saying, and how it says it.

Until recently, most commentators were sceptical of economic recovery. They forecast stagnation, at best. According to the conventional wisdom, the rising stock market was the result of ultra-low interest rates, rather than a signal of better times ahead. Their caution has helped keep me bullish about the economy and markets.

In a similar way, all this talk of bubbles keeps me feeling positive. Far too many people are ready to dismiss US and UK equities as being in bubbles. It has become a rather lazy put-down and I just don’t see the speculative excess which would justify using the word.

With the financial crisis relatively fresh in our minds, there is still a widespread distrust of the global economy and of most markets.

But just because an index has gone up a lot doesn’t mean it’s in a bubble, even if it has reached a new all-time high – like the US equity market and UK smaller company shares have done.

Valuations might be higher than they once were, but they are still within a normal range, and nothing to get frightened about. We might do well to remember that shares are meant to make all-time highs!

So yes, I am irritated by all this bubble talk. But as an equity investor, I’m also rather encouraged by it!

This article is taken from our FREE penny share investment email Penny Sleuth.
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2 Responses

  1. 09/01/2014, Panda wrote

    Everyone seems very excited by the indexes nearing or making new highs, but it’s worth revaluing the recent peaks to gain perspective. Take the December 1999 FTSE peak at 6930. Indexed by RPI we would need to reach 10440 to match it in real terms. Take July 2007 FTSE peak of 6710 and we would need to reach 8160. We are quite a long way short of either!

    • 10/01/2014, Clive wrote

      @ Panda

      I believe if you look at the FTSE 100 TR (capital PLUS dividends), the level now is higher than both the 1999 peak and July 2007.

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