Six signs of an asset bubble

21:00, Feb 06 2013
piggy bank
BURST BUBBLE: How to spot an asset bubble.

What do tulips, car licence plates and ostriches have in common?

They're among dozens of dodgy investments that have undergone spectacular booms and busts over the years.

History always repeats. After months or years of euphoria, the bubble bursts, the brown stuff hits the whirly thing and there is much wailing and gnashing of teeth.

Huge fortunes are made and lost.

It's mostly the latter though, because it's practically impossible to call a bubble at its peak.

You have to be able to sell your stake to an even bigger sucker before the bubble gets so bloated that everyone else is getting out, too.


Inevitably, there are a few lucky winners and a whole lot of losers.

Bubbles are transparent and ethereal.

Until the actual implosion - which is usually accompanied by a sad and undignified squelching noise - they can be very tricky to spot.

Here are six telltale signs for spotting a bubble before it bursts:

1 Forever unproductive

Some of the biggest booms have been built on assets which aren't necessarily very useful.

Gold is the classic example. It looks nice and has some minor applications in technology, but it's generally not much use.

While the shiny stuff's value has rocketed over the last decade, it's not because jewellers are suddenly doing a roaring trade.

Last year legendary investor Warren Buffett dismissed gold's ascent as a bubble in the making.

"As 'bandwagon' investors join any party, they create their own truth - for a while," he said.

He pointed out that the only way to actually make money from gold is by hoping someone else will buy it from you for a higher price.

"But bubbles blown large enough inevitably pop," Buffett warned.

2 Distortions

If you went to the supermarket and saw that the price of peanut butter had rocketed, you'd probably buy less of it or choose Marmite instead.

But in a bubble situation, rising prices will often stimulate demand rather than curtail it.

That means you'd eventually have to remortgage your home to get a jar of peanut butter despite the fact that its underlying utility - tastiness on toast - hasn't changed a whit.

That doesn't sound so absurd when you revisit the "tulip mania" of the Dutch during the 17th century. The introduction of a new flower, with several unique colour variations, caused a whole lot of speculation on tulip bulbs.

The higher prices rose, the more the Dutch believed that the tulip market had no boundaries.

Dealers stocked up their inventories, increasing the scarcity factor, and in a single month tulips increased in value 20 times over.

By the time the bottom fell out, some people had traded their land, life savings or houses for a bulb now worth as much as a common onion.

3 Greater fools

The tulip style of investing goes by the name of "greater fool theory".

In simple terms, that means buying something with the sole intention of flicking it off to another sucker.

While the supply of fools is plentiful, it is apparently not infinite. Some New Zealanders found this out the hard way in our own little re-enactment of the tulip craze.

This time it was personalised number plates that were all the rage. In the mid-1990s, investors crowded into bustling auction nights at top hotels and paid tens or hundreds of thousands for unique plates.

Then the market stalled, almost overnight. Eventually, there was no-one left who was willing to pay a king's ransom for a piece of plastic with no intrinsic value.

Today, the endlessly optimistic owner of a unique set of MAORI plates is still trying to get a sale for $99,000 on Trade Me.

Judging by the comments section, which has overwhelmingly slammed him as a "dreamer", the boom-times are well and truly over.

4 Herd mentality

October 19, 1987 - Black Tuesday.

A day which is deeply ingrained in the memories of many investors who got burnt in the big sharemarket crash.

While there were several elements involved, including fraud, investor behaviour played a big part.

New Zealand was hit much harder than most as the nation celebrated our recent market freedom.

Every man and their dog was getting into the sharemarket game, and everyone was supposedly making their fortunes. This was FOMO (Fear Of Missing Out) on a grand scale.

When big asset bubbles form, they often suck in people from all walks of life who wouldn't normally be interested in investing.

If the pizza delivery boy offers up a hot stock pick alongside your lukewarm extra-large pepperoni, then it's probably time to get out of the game.

Recently investors have been piling back into global stockmarkets, thought it doesn't look like there's enough hype to brand it with the "b" word just yet.

5 "This time is different"

If you ever hear someone say these words, smile politely, turn around and walk quickly in the opposite direction.

In their book of the same name, economists Carmen Reinhart and Kenneth Rogoff embark on a journey to show us just how little we have learned. They cover "eight centuries of financial folly" across 66 countries where these four deadly little words crop up again . . . and again . . . and again.

Whenever someone points to a bubble forming, gurus will sanction it as some kind of "new paradigm".

Just like 1987, the dot-com bubble that burst in 2000 left a sour taste in the mouth of many Kiwis.

Stock in a group of new tech companies connected to the internet - especially those prefixed with an "e-" or suffixed with a ".com" - went through the roof.

Analysts argued that they were a new breed and shouldn't be held to the boring old standards - like actually being able to turn a profit.

Instead of revenue and costs, they used metrics like site clicks and page views. This time, they said, it was different.

Of course, it wasn't. Many companies failed completely, while others plummeted from high-flying stocks to penny dreadfuls.

6 Easy credit

In his book Boombustology, Yale University lecturer Vikram Mansharamani hashes out some of the underlying characteristics shared by asset bubbles.

One of them is cheap money.

With interest rates at record lows in New Zealand and most of the world, money has never been cheaper.

The banks haven't returned to their pre-financial crisis levels of lax lending yet, but some of them aren't far off.

There's certainly some easy credit on offer, and thousands of people continue to leverage themselves to the hilt to buy obscenely-priced houses.

The jury's still out on whether the housing market is getting dangerously overheated.

But it's worth noting that Mansharamani identifies political manipulation as another telltale sign of bubble-blowing.

With the Government's hand poised to intervene, there's another red flag that house prices could indeed become big, spherical, and full of hot air in some parts of the country.