Bubbles and bursts

If you don’t have an idea what to write, it never hurts to find an anniversary and make it a topic of your post. This exactly what I did today and the event I’ve found is one not to be sneezed at. I bet few of you, even those who have been keeping track of capital markets for years remember well that the dot-com bubble burst exactly ten years ago, on 10 March 2010 2000.

Dot-com rally is a quaint example of the role of psychology on financial markets. Stock prices soared not because fundamental values or companies had been rising rapidly, but because of what investor had believed in. They had seen the Internet as a breakthrough invention. Indeed, it revolutionised our lives, made it much easier, but they had overestimated its role. No new era had begun, not every company which had begun to operate in the Net turned into gold. Many of them were actually worth very little.

The history of speculative bubbles, back from tulips in the Netherlands four hundred years ago, up till the last officially recognised crude oil bubble in 2008 (the mortgage bubble was penultimate, it’s still early to say whether what is under way on stock exchanges all over the world is a new bubble or not), is a long record of human folly and misperception, mostly notably is how the risk has been underestimated or forgotten about.

The major beliefs that underlie the growth of speculative bubbles are the ones that a new era has begun or that a price of an asset can rise endlessly, which strengthen with time (I still find it mind-boggling). This funny but destructive mechanism works orderly until it loses momentum the moment when there are no more suckers eager to buy a certain asset (please note this is one of possible explanations). What causes a rise of a bubble and what pops it have been subject of numerous debates among economists. I will be trying to explore those issues in my MA thesis. From time to time, I’ll be sharing with you some my new discoveries and conclusions. This topic is a really fascinating combination of economics and psychology.

And at the end I have to eat a humble pie. Once again, what shouldn’t have even surprised anyone, my stock market forecast was far off mark. In late January I forecast much lower levels of stock indices. Today they are a step away from reaching their new peaks in the current bull market. I can make out where the markets are going, but what drives them in such a direction remains beyond my comprehension. Have we forgotten about the ‘R’ word once again? This word is RISK.