Prosper From Financial Bubbles... And Protect Your Profits: Money for Main St book series

By Steven Benard

As financial manias and bubbles become ever more common, even as they are often dismissed, many investors have begun to ask how they can protect themselves from the financial devastation that occurs when these bubbles pop. Better yet, how can investors take advantage of the profits from these financial bubbles, while recognizing when the bubbles have risen too high and getting out in time to lock in those benefits. This book seeks to answer those and other important questions, including the following:

1. What is a bubble?

2. What are the lessons of history that I can learn from previous financial bubbles and market manias?

3. What is the best time to get into a new bull market that could become the next bubble?

4. How can I recognize when a market is close to topping out, so I know when to run for the exit?

5. What kind of news and financial signs will I see when a bubble is approaching its final blow-off top?

6. What are common, recurring characteristics to watch for in a financial bubble?

7. What role do central banks play in creating financial bubbles?

8. What are the attitudes and psychologies that contribute to a bubble? Am I manifesting some of them such that my investments may be vulnerable?

All these questions and more are probed, discussed, and answered in this book. Find out how you make profits from the next market mania or bubble, but without risking your investments when they inevitably pop.

• Language: English
• Publisher: Steven Benard
• Release date: Aug 9, 2018
• ISBN: 9781386887836

Book preview

Chapter 1

What Is a Financial Bubble?

Before we delve into the various aspects of a bubble and what one looks like, let's talk about what a financial bubble is. There are various terms that are used by economists, investors, and market analysts that denote a bubble. Here are some of those terms:

Financial bubble

Economic bubble

Market Mania or just Mania

Asset bubble

Market bubble

Speculative bubble

Price bubble

Speculative mania

Balloon

Asset inflation

My personal preferences among these terms are asset bubble and financial bubble because they accurately identify the connection with a specific type of financial asset. They are also the most commonly-used terms. But all of the above terms are generally used interchangeably. The bubble that peaked in the 2007-2008 time frame was often called a real estate bubble, even though the stock market also experienced a bubble and a subsequent crash simultaneously with the real estate market. I like to use the asset term that specifically matches the bubble type. In other words, during the 2007-2008 market mania and the resulting collapse, there was both a real estate bubble and a stock market bubble. Both collapsed with devastating ripple effects throughout the global economy.

So what's the difference between a bubble and a market rally or just a bull market? Is there really much of a difference between these market manifestations? Aren't they all just the same thing?

The simple answer is no. Here's why. Market rallies are common occurrences that simply denote a temporary period of time, usually of a short-term nature (days, weeks, or a few months), during which a market is rising sharply, usually due to a sustained period of strong market data and/or good news that suggests strong investment returns are ahead. A bull market is usually of a longer duration, lasting over several weeks, months, or even years.

Historically, bull markets and rallies have occurred because of strong and favorable market conditions. However, in recent years, rallies have often occurred even when bad news hit the markets. Why? Because the anticipation of central bank interventions has created the expectation that the markets will respond strongly to quantitative easing, artificially-low (yes, even manipulated) interest rates, and other central bank policy changes and influences.

Bubbles Defined

So just what is a financial bubble, then? And what are the characteristics of a bubble that make it distinctive compared to other types of market activity? What traits make them so economically and financially dangerous and destructive as they come to an end?

In a general sense, an asset bubble is a market manifestation in which the price of an asset becomes exaggerated, and so grossly over-inflated that it no longer reflects the intrinsic value of the underlying asset. Dr. John Hussman points out that the nature of a bubble is such that long-term returns on that asset drop dramatically as investors pay ever-higher prices for an asset, even as returns on the asset dwindle. The price often escalates rapidly, especially in the final stages, and is then followed by a sharp sell-off as investors panic and seek to get out of a market in which there are very few or no willing buyers. This is when the bubble bursts and the same asset price goes into free-fall.

Bubbles occur when investors dismiss market risk to the extent that they believe that prices will continue to escalate such that they will become profitable in a relatively short period of time. If you are thinking that you'll cash in quickly on your investment, then there's a good possibility you're investing in a bubble.

The essence of a bubble, then, is an asset marked by a rapid price expansion followed by a sharp price contraction. And usually, the contraction is much more rapid than the expansion was. The pace of contraction or decline is sharper than the rate of incline during the expansion or growth phase. This is a typical characteristic of a bubble during its popping phase. Charts of past bubbles, as we will see in future chapters, have historically shown that the contraction phase of a bubble occurs more rapidly and more sharply than the expansion or growth phase. Markets go up on an escalator, they come down on an elevator, says David Stockman, former White House Budget Director.

In chapter 5 of this book, we will discuss characteristics of a market bubble. We will discuss how to recognize them so you don't get caught in their trap and lose your investment or savings.

Chapter 2

A Short History of Bubbles

This book isn't intended to provide a comprehensive history of bubbles, but by studying a few case histories, we can learn some important lessons.

For one thing, you'll soon see that a bubble can form on the price of many different assets, including many that we never would have expected.

When you think about market bubbles, you probably don't think of very many instances or examples of bubbles, but they're actually much more common than most people realize. In fact, the day I wrote this, economist Dr John Hussman said, We actually view this period as the extended top-formation of the third speculative bubble in the past 16 years, not as a representative sample of things to come. Three economic bubbles in 16 years! They are much more common than most of us realize! And they're becoming more common, not less so, in recent years, as central bankers engage in more and more unprecedented measures (to use the words of former Fed Chairman Ben Bernanke), in attempts to artificially boost the financial markets.

For our purposes, we'll review a few of the more unusual bubbles in history. Part of the reason for this is to point out how diverse they often are, but they also teach us some important lessons about remaining constantly on the lookout for both the risks and opportunities that bubbles create. There's no mistake about it: there are great dangers, but also tremendous opportunities, in investing in asset bubbles. So let's get started...

Tulip Mania

Perhaps the most frequently-studied asset bubble in history is one that is termed tulip mania. What? A bubble named after a flower? You've got to be kidding, right? Nope! Tulip mania really was named after the flower we all love to see in our gardens – the common garden tulip!

Tulip mania was the first major asset bubble in recorded history in which prices skyrocketed to record levels and then crashed. It's often used as a case study for what a bubble looks like and what its impacts are.

The tulip bulb and flower was introduced to the Dutch from Turkey in 1593. Many people think of the Netherlands as the original source for tulips, not realizing that they actually originated in Turkey.

The many color variations and novelty of the flower created great demand for the bulbs. A non-fatal virus eventually caused striations in the color patterns on the flowers, as shown in the tulip mania drawing from that time. Within a few decades, the bulbs for tulips became so popular, and there was such demand, that people were trading bridal dowries, their land, their life savings, and even their entire estates just for a single tulip bulb. In one economics book, one story tells of 12 acres of land being exchanged for a single tulip bulb. There were even tulip bulb futures contracts created in the trading of the bulbs! Imagine that! Futures contracts, just like crude oil contracts are traded today, were once exchanged for tulip bulbs!

The peak of the tulip bulb speculative bubble occurred in 1633-1637. Prices for the bulbs rose until there was no relationship between the intrinsic value of the bulbs, and the prices that speculators were willing to pay for them. Garden suppliers bought up the available supply of the bulbs, thus increasing prices and demand even further. At one point, the price of tulip bulbs increased more than twenty times – in a single month.

The crash occurred in early 1637 as doubts rose that prices could continue to rise. Eventually, some wise investors began to see an opportune time to sell and collect