Hindsight really does shed clarity on a situation. It all seems so simple when we can look back at things and tie the ends together. The opportunities we missed, the mistakes we could have avoided. It all seems so simple. Investment bubbles are like this.
Take tulips. Back in 1600s tulips became quite the thing among the well to do in Holland. They liked the flowers so much that prices for the bulbs began rising until they peaked in 1637 when a single bulb was selling for today’s equivalent of $1,250. In the height of hysteria, some bulbs were thought to be too valuable to plant and were displayed ungrown. Some traders back then were making over $60,000 a month in today’s dollar. I think you can guess the outcome of this insanity. One day, panic spread and the bubble burst. It was the end of the craze and the end of “tulip fortunes”.
You might think we should have learned some lessons. You probably should think again. The Internet bubble of the late 1990s was a classic case of what the then head of the Federal Reserve Board, Alan Greenspan called “irrational exuberance”. A good example of this exuberance was a company named Pets.com. In an Initial Public Offering led by Merrill Lynch, Pets.com raised $82.5 million by selling 7.5 million shares to the public for $11 per share in February of 2000, despite the fact that the company had lost $42 million during the last quarter of 1999 on sales of $5.2. In the first day of trading, the price of the stock doubled. On paper, fortunes were made and fortunes kept for the lucky few who turned around and sold their shares. For those who stayed to the bitter end, shares traded at just $0.19 the day it was announced the company was being liquidated. It was just 268 days after the IPO. Pop went the weasel.
Unless you do literally live in a cave, you’re probably familiar with the bursting of the recent housing bubble and the meltdown on Wall Street of subprime mortgage paper. Virtually every investor took a hit including many of the major Wall Street firms that had a drink of their own Kool Aid. Bear Stearns and Lehman Brothers went belly up and Merrill Lynch was saved in the eleventh hour by folding itself into Bank of America. The government decided to prop up the major companies through TARP money. Average investors were left to pretty much fend for themselves.
Hindsight of course isn’t foresight. Recognizing the next bubble is far more difficult than talking about the last. I don’t pretend that I have some foolproof methodology to detect bubbles, but here’s some things to think about.
With all the different types of investments you can put your hard earned money in, it is rare that one asset class will perform at the top of the heap for very long. If an asset class is overstaying its time at the top, it may be time to take a hard look at why it’s still there.
Because you should own a number of different asset classes, rebalancing them from time to time helps take a little off the top and keeps any one class from dominating the entire portfolio. You’ve probably heard this before. Now you’ve heard it again.
Although I have no scientific proof, after over three decades in the investment business, I’ve come to the conclusion that a lot of folks, despite good arguments to the contrary find it easier to buy at highs than lows. Real Estate is historically cheap and interest rates are incredibly low. If I was in the market for a house, I’d be buying now. Ok- so you think we haven’t seen the bottom of the market. The point is we’re probably close to the bottom and you’re not going to catch it anyway. Have you ever got in at the absolute bottom and out at the absolute top? Me neither.
Above all, avoid the feeding frenzy of a bubble. When your grandmother wants to start flipping condos in Naples, Florida it’s a pretty sure sign that the hysteria is starting to peak and it’s time to move on. I remember back in the 1990’s when all the IPO’s were hitting the street. It became almost a status symbol to be allocated some shares in the Internet companies. It wasn’t necessarily good investing, but it was fleeting fame. Something to talk about over lunch- impress your friends for 5 minutes with how important you were to your broker. Your broker made some money- you probably lost a good bit of it.
Remember, there’s always people behind the bubble. It’s in their interest to keep the bubble alive for as long as they can. They’re making money on it. Most of the time they need the average investor to keep the prices rising. You will be told all sorts of nonsense and it can be very convincing. Simple common sense can go a long way here. Think Pets.com. and don’t drink the Kool Aid.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.