Are we in a bubble?

Are we in a bubble?

ARE-WE-IN-A-BUBBLE

Markets analysts and media love to make gloomy predictions. We are all familiar with titles such as “the end of capitalism” or “the next economic collapse”. They see bubbles everywhere; in Canadian housing, college tuition, bonds, stocks, China, junk debt and of course central banking.

Ex Fed President Ben Bernanke couldn’t see a housing bubble back in 2007 while last week Mario Draghi and BOJ governor Kuroda supported that they cannot see any bubbles. Ben Bernanke the next year (2008) had to deal with one of the worst bubbles that occurred in financial history while for Draghi and Kuroda the future will show if they are right or not.

Bubbles are created by euphoria, mania, excessive leverage, capital misallocation, irrational behavior and zero or negative rates policy where liquidity does not flow in every sector of the economy equally. A bubble is created as a buyer is willing to pay a price much above the fundamentals, as the buyers expect to sell the asset to other investors who have a more optimistic perception about its future value.

At the moment there are some evidences that a few assets are overpriced but this does not mean that we are in a bubble. When central banks have adopted an unconventional monetary policy where printing money and have negative rates means that asset prices are very difficult to be evaluated. The issue with bubbles is not that they are very difficult to be identified but also even if we have the ability to know that an asset for example is in a bubble mode it is impossible to know when the bubble will be burst in order to profit from it.

A good example is the 2000 dot- com crash where so many investors and traders had predicted that this mania will not have a good end and they were shorting the index aggressively for months… after huge losses they did not have other option from accepting the huge losses before receive a margin call.. the bubble burst in the 2000 dot- com sector however it took much more time to occur than many investors were expecting.


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