It Is Time To Learn How To Avoid Speculative Investment Bubbles
We have just come through three big speculative investment bubbles: the great stock market bull of the 1990s, the speculative run-up of housing prices that ended over a year ago, and the China-driven commodities boom that ended last fall.
Each were followed by painful crashes and price readjustments that damaged many investors’ wealth. Indeed, we are still working through the pain of the housing collapse and stock market decline.
Speculative bubbles have occurred in markets for hundreds of years, and yet investors never seem to heed the lessons of the last bubble before getting sucked into the next one.
Stocks to houses
U.S. investors moved too quickly from stock mania to housing mania in the early part of this decade.
A nearly 10-year boom in stocks through early 2000 occurred on enthusiasm over globalization of the economy, the growth of high technology industries, falling inflation, and increased productivity due to the Internet.
Never mind that falling inflation had never been a reason for expanding stock markets in the past (indeed, during the 1960s boom inflation rose rapidly).
Also, the Internet had not been dominant enough in the 1990s to enhance productivity. Many high tech companies, especially the dotcoms, never fulfilled their promise.
When the crash came in 2000 and extended over the next two years some investors decided that housing was a safer, surer long term bet.
They were prompted by the availability of cheap borrowed money after the Federal Reserve cut rates in the wake of the bear market in stocks and a recession.
The boom was also prompted by the belief that second homes in scenic areas would become more popular as Baby Boomers could work remotely from their homes or would want to retire to scenic shorelines and mountain tops.
Disappointed again
The outcome has been disastrous as home prices have plummeted by record amounts in the most popular areas and aren’t expected to begin rising again for years.
The third boom occurred in commodities, dragging the stock markets up with it, on the conviction that newly emerging economies like China and India would suck up a vast amount of natural resources, pushing up prices of oil, metals, grain, and other physical goods. That bubble crashed into a wall last fall in the midst of the credit crisis and oil plunged from $140 a barrel to as low as $40 in less than six months.
The next boom 
So how will we recognize the next boom? One way is to look for stories that sound good, promising new paradigms that will break with historic patterns of price relationships.
Here are some current “stories” that might qualify:- Inflation will skyrocket due to increased government borrowing and investors will flee to the safety of gold.
- The dollar will fall and the U.S. economy will decline. Foreign governments will sell our bonds, sending interest rates soaring.
- China, India, Russia, and Brazil will continue their rapid growth independent of trends in the United States.