Bubble, Schmubble
Here we are just 8 months from the stock market’s bottom, a bottom, mind you, that was created by a massive credit crunch and the worst recession in decades, and already we are hearing talk that another bubble may be forming. Some “experts” are trying to warn us that the government’s easy monetary policy and/or fiscal stimulus will be enough to drive the prices of some “stuff” (gold, commodities, stocks, houses, whatever, etc.) to new bubble levels. First of all, we still struggle with the definition of a bubble. It seems to me that we can only truly define a bubble after it has burst. In the middle of the 1990s Tech Bubble, many were calling it a “bull market,” a “paradigm shift” or the “next big thing,” and not a bubble. The tech executives, who became billionaires on the back of that bubble, would probably conclude that bubbles are not universally bad. Some think that all of the world’s economic problems are due to the latest bubble. I would consider this a topic worthy of a healthy debate. Others think that new rules are needed to prevent the next bubble. I would note that the financial services industry is one of the most highly regulated industries out there. Also, to my knowledge no one has been convicted for breaking any laws in regard to this crisis.
Second, bubbles may be the natural result of rational people searching for irrational returns. When a person could buy a house for no money down and no credit check and then turn around and sell it within six months for a $50,000 profit, why not do it? There may have been warning voices at that time of potential negative consequences, but the allure of quick profits is simply too powerful to resist for some folks. The same thing happened with amateur day traders in the late 1990s. This part of human behavior has been observed over and over again at least from the South Sea Bubble in 1719. As long as investors have the opportunity to place their money at risk for the possibility of reward, excesses, or bubbles if you must, are likely to occur. Charles Kindleberger, in his excellent book, Manias, Panics and Crashes, agrees – “Speculative excess, referred to concisely as a mania, and revulsion from such excess in the form of a crisis, crash, or panic can be shown to be, if not inevitable, at least historically common.”
Third, much of the bubble talk heard these days appears to be centered on one of my big pet peeves – the ceteris paribus (all else held constant) argument. This line of reasoning goes something like this – “If the current trend (weak dollar, loose monetary policy, rising stock prices, whatever) continues without changing (this is the ceteris paribus part), bad things will happen.” This argument is cheap and easy to use (probably why we see so much of it in the media) and it has a certain amount of appeal to it. It’s almost always hard to disagree with the conclusion and it usually seems to make sense. The fact that things always change rarely surfaces when the ceteris paribus guys are around. Things always change. Supply will increase to meet more demand. Higher prices will eventually lead to lower incremental demand. Occasionally, a black swan flies in to change all expectations and assumptions.
It seems wise to keep a vigilant eye on the signs and evidence of bubbles, but from my vantage point, I see nothing bubbly about the stock market right now. Valuations are reasonable, money on the sidelines is plentiful, sentiment is still mixed and earnings are still growing. Sounds like a recipe for anything but trouble.
“Double, double toil and trouble; Fire burn, and caldron bubble.”
– The Witches from Shakespeare’s Macbeth