Bubble Bath
March
Remember when we were kids we’d blow bubbles and watch them slowly drift away. The bigger the bubble, the better. We understood they couldn’t and wouldn’t last very long, and sure enough, to our great delight, they all would pop. But then we’d blow more of them and watch the process repeat itself. It was all great fun – no harm done.
The image of a bubble carried over into the world of finance where the stakes were much higher. Bubbles could still be fun – for a time at least. When they burst, however – which they always did – great distress followed. The critical question of course was just when that would happen. Timing was everything.
And so down through the centuries average people and more sophisticated “investors” have been caught up in speculative bubbles, swept along by popular enthusiasm and outsized expectations, i.e, the prospect of substantial returns. Those familiar with this phenomenon inevitably point to such high profile bubbles as Tulipmania in the Netherlands in the 1630s, the South Sea Bubble in France in 1720 the Florida real estate bubble of the 1920s, and more recently the Dot com Bubble and the Housing Bubble..
As the Stock Market continues to advance to new heights early in 2015 the debate begins anew. Are we once again entering bubble territory? Has, as former Federal Reserve Chairman Alan Greenspan once phrased it, “irrational exuberance” taken over, or do stock price increases merely reflect better corporate earnings and exciting new business frontiers?
Bubbles generate euphoria. There is excitement, optimism and profits aplenty. What homeowner, for example, in the early 2000s wasn’t thrilled to see the value of his house increase sharply year after year. He could not overlook the fact that valuations were many times what he’d originally paid – and not that many years ago. Eager to cash in on this windfall he signed up for home equity loans which released thousands upon thousands of dollars available for purchases of all kinds. There were those warning that house prices were unsustainable, had never before in history risen so sharply, that bubble conditions existed, but why listen when other voices suggested the housing market had simply entered a new phase. Then it all collapsed in 2008 and seven years later we are still feeling the effects of the crash.
Are we more vigilant today or just as prone to explain that “this time it is different?” Of course bulls and bears have always debated each other, both arguing their case with conviction, certain that the other side has misread or misinterpreted developments. Today we hear, for example, that the current rise of stock prices to new highs is not like the Dot Com mania (1997-2000) where companies with little or no revenues and obviously unprofitable were bid up to breathtaking levels. On the contrary today’s high flyers have lengthy track records, enjoy substantial revenues, are profitable and whose stock prices have not risen into the stratosphere. Moreover, current market leaders are operating in new exciting business areas such as social media, cloud computing, mobile networks, cyber security, biotechnology and robotics blazing the trail toward the economy of the future. Furthermore, investors today are more sophisticated, have learned to be more critical after the Dot Com and housing debacles. And then there is the Federal Reserve which dropped the ball last time and so will now scrutinize developments more carefully and intervene (e.g., by raising interest rates) before matters spin out of control.
This is all wishful thinking, the worriers declare. Bubbles are addictive; attract people who are eager for the fast buck, who overlook warning signs and whose initial profits serve to draw them in ever more deeply. Inevitably such folks will find a way to rationalize “bubbles” by insisting they represent true value, not speculative fantasies. (“Companies will grow into their stock valuations.”) There is, moreover, boatloads of cash in corporate and private hands chasing about recklessly for higher returns, scouring the economic landscape for promising opportunities. Will government regulations tamp down speculation and nip bubbles before they swell? History does not offer much comfort here. Regulators are reluctant to toss monkey wrenches, douse economic exuberance and have as much trouble as everyone else distinguishing between future prospects and unhealthy binges.
And so today the worriers are pointing to sectors of the economy they deem shaky and vulnerable. Too much money is chasing after relatively small bio-tech companies. Social media enterprises, they insist, are highly overvalued while private equity and venture capital money is pouring into little more than start-up operations driving valuations beyond all reason. Then, too, the housing market could become risky again, thanks to new regulations permitting smaller down payments for mortgages. In addition stock market gains are clearly outdistancing the real growth of the U.S. economy where GNP increases are modest, wage gains barely perceptible, consumption restrained and worker productivity disappointing.
The Bubble hunters will no doubt continue their search, confident that human nature, and good old-fashioned American optimism will confirm their fears. Until that happens, however, the party will go on.