Investment Bubbles
Investment bubbles can occur at least once every ten years is what it seems, and must be avoided. One of the best strategies to create a long-term investment strategy is to stay clear of making huge losses (such as the event of an investment bubble bursting). Two recent bubbles in investment that the markets have been through in the past decade included the technology stock market between 1997 and 2000 as well as the real estate and housing bubbles over the past five years. Both resulted in terrible hangovers (and massive expenses) on investors who had too much capital invested when they burst. It’s extremely difficult (and usually takes a long time) to recover huge losses of 25 to 50 percentage. It is attractive to put your money into a sector that is booming (or keep investing in a sector that is booming) as the price is booming and you hear from other investors about how easy money they’re making. But history has proven that the risk/reward associated with investing in this way isn’t exactly appealing.
Signs for an investment boom
All are involved. Individuals who aren’t normal stock market investors put their money into investing. It’s easy to earn rapid money in this sector. It doesn’t require any knowledge or knowledge of the market; simply purchase whatever is rising most. Schoolteachers, cab drivers retired people and a lot of other individuals who haven’t ever been in the stock market are pouring into.
It’s a feeling that you’re not losing. Excellent time-bound spiritual “story”.
The dramatic increase in value and prices in the span of 3 to 5 years.
Valuation doesn’t matter. A ridiculously expensive valuation in comparison to historical. Creative and innovative ways to assess the assets (since using standard measures makes them appear absurd).
buying simply because they’re going up and not because of any reasoned analysis. Momentum investing. The majority of buyers are traders rather than investors.
Leverage is a type of “creative” funding. Stock investors in the tech sector day trading on margin. Homebuyers who take advantage of 40-year adjustable rate loan with interest-only terms and lower teasers.
Artificial causes driving the market upwards.
Excess liquidity driving the rise.
Fantastic headlines. This is the topic that everyone talks about. Every day, news stories are reported about billionaires that are being made every day within the bubble market.
Incredibly fast and rapid inflows of capital in the sector over the past three years.
This is the Chinese Stock Market Bubble.
The market that appears to be the most like a bubble investment sector, as previously described, is the Chinese market for stocks. Warren Buffet commented on a recent visit in China that he did not think the Chinese market appealing after the huge growth. Warren has recently sold the PetroChina stake. It is believed that the Chinese economy is on fire and growing at about 10 percent per year. China’s future is an exciting long-term story. The Olympics will be held in China in the year 2008. This is a clear positive trend in the world of today. Bubble markets always have compelling stories of how this trend is stronger and better , and is more durable than other trends. It’s a different world in relation to the bubble that is in this moment. Don’t you get it? But how much do you have to have to pay for it?
The Chinese market for stocks is currently showing all of the indicators of bubble markets like those listed above, like the previous housing market and tech stock bubbles were. It is estimated that the Chinese market is currently trading at 45-plus times earnings, compared to 16 times in that of the US market. It increased by more than 100 percent in 2006 and nearly doubled in 2007. The number of accounts for investment in China doubled in the year 2006. Workers in beauty parlors are talking about the best stocks to invest in as well as “doing their own research”. The Chinese are left with few investment options at present, since fixed income investments are lesser than inflation. A flood of capital from around the globe has been flowing in to invest in Chinese stocks. The amount of US mutual funds focusing on China has increased dramatically, and inflows into them are rising dramatically. What is the likelihood that be the Chinese stock market keep rising rapidly from here (to greater levels of overvaluation)? It certainly can. But for a rational long-term investor, the risk/reward relationship is not optimal right now, according to me.
What causes the termination of a bubble in the market?
Excess demand/reduced demand. The price increases attracts more capital , which results in an increase in the supply of the asset (more technology stock IPO’s/stock issues in addition to more home construction, and more Chinese stock issues and IPO’s). A housing boom caused prices for housing to rise so much that the average homeowner was unable to be able (without the use of creative financing) to purchase a typical home. This is a decrease in the demand.
A shock to the economy or an external shock like the threat of terrorist attacks, recession or terrorist attack.
Simply market fatigue when the excessive optimism runs out of the air. As soon as the prices of stocks begin to decline, you will see a reverse momentum rush to the exits, which is similar to the upswing. When this happens, people start selling because the price is falling, just as they purchased because they thought the price would go up.
The Chinese market could get into trouble for a variety of reasons like increasing inflation in China (food and energy) and the stronger currency, which with rising inflation reduces their competitive advantages as well as slowing economic growth from the current high (10 percent) level, government measures to slow down the economy/stock market/inflation as well as dramatic increases in stock issued in China, and changes in the rules of the stock market that permit Chinese investors to put some of their funds out of China (and in other market such as Hong Kong). Chinese stocks have been able to roll over slightly in the last few months. I’m still positive about China however, I’m not so bullish on Chinese stocks at the moment.
