It’s Bubble Time! Wisdom & discipline will separate winners from victims
It’s impossible to predict with certainty how much more insane our financial markets will get before an inevitable correction. But my personal bet is: A lot!
For my reasons why, take a few minutes to watch the chapter on bubbles below from The Crash Course. For those who haven’t seen it before, the takeaway is this: bubbles pop only when greed in the market has been exhausted:
Bubbles make no sense economically. Or rationally. But they happen all the time as a part of the human condition.
Even while financial bubbles are enabled by dumb monetary and banking decisions, their actual genesis is rooted in primal human emotions. Greed on the way up, and fear on the way down.
The hardest part about these bubbles is not being swept up in them. As the above video shows, history is chock full of asset bubbles. We humans just never seem to learn. Like Charlie Brown’s endless attempts to kick Lucy’s football, we get suckered in by the promise of easy riches, only to end up flat on our back when the market suddenly yanks that promise away.
Wash, rinse, repeat.
Most of you reading this might be thinking “Hey, I’m a reasonable intelligent person. I won’t fall victim to the next bubble.” Perhaps, but maybe not. The numbers say that the majority of you will. Unfortunately, being smart — even a genius — is no protection against being ruined by a bubble.
Remember from the video that even Sir Isaac Newton, easily one of the most brilliant humans ever to live, got his clock cleaned by the South Sea Bubble:
(Source)
Bubbles are much easier to enter than to exit. As they build, all your friends and neighbors are diving into the pool and enjoying easy riches. You deserve some of that good fortune, right? And there will be plenty of eager parties willing to help you get on the bandwagon.
But when the bubble pops, though, action becomes much harder to take. At first, everyone assumes that the sudden drop is a temporary aberration and that the party will shortly resume. As prices fall further — and they typically fall at a faster rate than when they were rising — folks become paralyzed by fear on the way down, slowly realizing that their paper profits may indeed be gone for good. At first they’re unwilling to give up the dream of the “sure thing” they so recently had, and then, once the losses start mounting, they find themselves resistant to locking in those losses by selling. Instead, they hold on to the increasingly threadbare hope that prices will at least recover to where they can ‘get their money back.’
Of course, that never happens. For all those who bought in during the mania, their money was hopelessly betrayed the moment they placed their bet. And that’s what bubbles are – merely bets. And that bet is: I bet I can get out before everyone else.
That’s mathematically impossible for the majority. It’s really only possible for a very tiny few who have the vision and the discipline (and more often than not, the luck) to pull it off. Very rare are the people who get out at the top.
Don’t Be A Victim
So, to avoid becoming victim in the future, the first thing you need is the clarity to know when you have a bubble on your hands.
Well, it really doesn’t get any clearer than this:
Why Toronto (and Other Cities) Inflate Housing Bubbles to the Bitter End
Feb 20, 2017
“Let’s drop the pretense. The Toronto housing market and the many cities surrounding it are in a housing bubble,” Bank of Montreal (BMO) Chief Economist Doug Porter told clients in a note last week.
Many have called it “housing bubble” for a while, but now it’s official, according to BMO.
In January, the benchmark price and the average price were both up 22% year-over-year, with the average price of detached homes up 26%, of semi-detached homes 28%, of townhouses 27%, and of condos 15%. Double-digit price increases have become the rule in recent years.
But this jump was “the fastest increase since the late 1980s – a period pretty much everyone can agree was a true bubble – and a cool 21 percentage points faster than inflation and/or wage growth,” Porter explained in his note, cited by BNN.
(Source)
Holy smokes! Or rather, what are people smoking up there? Bubble weed, or something. A 22% yr/yr gain? On top of a string of recent years of double-digit gains?
Here are two more features about bubbles we need to keep in mind:
- Bubble exist when prices rise beyond what incomes can sustain
- Bubbles always have a blow-off top
First, house prices rising a ‘cool’ 21 percentage points above wage growth over a single year is the very definition of bubble behavior. Simple math tells us that anyone who borrows to buy property eventually has to pay that loan back.
The money to pay back that property loan comes from wages. Ergo, property prices and wages cannot depart from each other forever, or even for very long, without a lot of repayment defaults resulting.
As for ending in a “blow-off top”, that’s just how history tells us bubbles finally exhaust themselves. They draw in every last sucker and lazy-thinking ‘investor’ until there’s no “greater fool” left willing to pay a higher price. This doesn’t require 100% participation from the local population; only 100% participation from everyone who can be drawn in. When that finally happens, that’s when the bubble bursts all of its own accord.
There’s another way for a bubble to end, but it practically never happens. Responsible bankers and lenders could prevent the bubble’s formation by simply not lending ridiculous amounts. It almost never happens for the same reasons that people buy overpriced houses: greed and our social programming to follow the herd. If all your banker buddies are making big bucks writing loans to anyone who can fog a mirror, then you’ll be rewarded for doing the same. Nobody wants to be the lone, unpopular voice urging restraint when the crowds are going wild.
The quotes below from the 1850’s show how this dynamic is nothing new to society:
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”
“In reading The History of Nations, we find that, like individuals, they have their whims and their peculiarities, their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.”
?Charles Mackay,in Extraordinary Popular Delusions and the Madness of Crowds
Well, the good people of Toronto — as well as Vancouver, Palo Alto, Melbourne, and a large number of other real estate markets — have fixed their minds on the delusion
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