The REAL Reason for Investment Bubbles: Bubble Logic

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Beyond Buy-and-Hold #29

What’s a “bubble”?

It’s not a price. It’s not an event. It’s not a time.

It’s a way of thinking.

If we think using “bubble logic”, we will see bubble prices. If we think using bubble logic, we will see bubbles develop and pop. If we think using bubble logic, we will live in an era of bubbles.

To stop bubbles, you need to change how you think about investing. Nothing else will do the job. And nothing else is needed to get the job done. Bubble logic is the entire problem.

Everyone LOVES a good market bubble

So what is “bubble logic”?

It’s magical thinking.

Magical thinking never works in the real world. When I was a boy, I watched “Superman” one too many times and came to persuade myself that, if I jumped from the top of the steps, I would be able to fly. You know what happened. We all have come face to face with the Reality Principle at some moment in our lives. The Reality Principle does not suffer fools.

The stock market does. At least for a time it does.

Say that all us investors decide that we would like our stock portfolios to be twice as large as they are. Can we make that happen?

Sure.

We bid stock prices up. It happens. The thing is done.

But the Reality Principle does not like this sort of thing. So those phony price bump-ups (they call them “bull markets”) never last. If we want to be able to retire on time, we’re going to have to pump up those retirement accounts the old-fashioned way — we’re going to have to earn the money. Drats!

The problem with bubble logic is that it works while it works – sometimes too well!

For a time, we can engage in Bubble Logic. The investing experts won’t mind. Most of them are employed in The Stock-Selling Industry. They understand. They won’t say a word.

Some people wonder where bubbles come from. They are the natural state of the market. Of course we are tempted to bid stock prices up to insane levels. Creating bubbles comes as naturally to stock investors as playing in the dirt does to six-year-old boys. It’s what they do.

Can bubbles be prevented? Yes, with effort. Stopping stock bubbles is like keeping your weight where it should be. It’s a never ending battle.

We stop bubbles by selling stocks when prices rise to insanely high levels. Market timing—that’s the ticket. Now you know why The Stock-Selling Industry hates it so much. Most of the people they call investing experts should be more properly referred to as “bubble-creation experts.”

Investment bubbles beget more investment bubbles

Bubbles always spread. Like roaches, there is never just one. Think about it. If people see tens of thousands or hundreds of thousands of play money in their accounts, what are they going to do with it? There’s a good chance that they are going to use it to build another bubble. The stock bubble caused the housing bubble. Our stock portfolios were reporting so much play money that it would have taken an army to stop us from building a housing bubble.

Bubbles never really go away. We fool ourselves into thinking they do. We say the bubble popped. But what really happens is that bubbles are transformed. The polarities are reversed and a bubble becomes a black hole until the next mood swing. The biggest bubbles become the biggest economic black holes of all — economic depressions. Yikes!

Wait. I’ve thought of a way to stop bubbles (and economic depressions!).

Since bubbles are the product of Bubble Logic, all we would have to do is to stop listening to the stock-selling experts and give up the Bubble Logic.

Real Logic says that stocks are worth buying when they are low-priced or reasonably priced and not when they are insanely overpriced.

The Reality Principle approves.

Rob Bennett often writes about why short-term market timing always works. His bio is here.

( Photo by Pink Sherbet Photography )

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4 Responses to The REAL Reason for Investment Bubbles: Bubble Logic

  1. But Rob, how do you evaluate “low-priced” or “reasonably-priced”? Do you look at P/E ratios? Do you look at charts and try to spot patterns? Personally, I don’t think you should time the market with your core investments, especially your retirement investments (although it’s okay to set aside a little “fun money” to indulge in your market-timing curiosities). But that’s just my opinion … and I’m sticking to it 🙂

  2. that’s just my opinion … and I’m sticking to it

    I like your spirit, Afford-Anything. Thanks for taking time out of your day to share your thoughts with us.

    My take is just the opposite of yours. My view is that it is okay to follow a Buy-and-Hold strategy with a tiny bit of gambling money. But for the money you plan to use to finance your retirement, you need to be willing to practice long-term timing. If you don’t, you’re ignoring price when you buy stocks. And I have a more than a little bit of a hard time seeing how that could work out in the long run.

    But there’s a good reason why God created both chocolate and vanilla ice cream, no? Lots of my friends are Buy-and-Holders. I can honestly say that I don’t think I’ve ever met a dumb Buy-and-Holder. Buy-and-Holders are smart investors and even those of us who disagree with them need to be giving their views serious consideration.

    The valuation metric I use is P/E10. That’s the current price of the index fund over the average of the last 10 years of its earnings. Benjamin Graham (Warren Buffett’s mentor) came up with P/E10. it has been popularized in recent years by Yale Economics Professor Robert Shiller.

    Thanks again for stopping by, Afford-Anything. I hope we meet up again.

    Rob

  3. Hi Rob. Well written. The sad thing is that during the “bubble” a lot of the so called experts on Wall Street and the local wannabes are not taking real peoples hard earned retirement money into consideration. When the bubble re-polarizes and morphs into prices that are close to OK the real losers are those that are newly retired or close to retirement. Their brokers are telling them, don’t worry it will come back in a year or so. Yeah right!

  4. The sad thing is that during the “bubble” a lot of the so called experts on Wall Street and the local wannabes are not taking real peoples hard earned retirement money into consideration.

    I certainly agree, Keith.

    I am a big believer, though, in the idea of taking a sad song and making it better. We have something available to us today that no group of investors living at earlier times in history had available to them — the Internet. What if we supplied middle-class people with good investing advice, honest investing advice, research-based investing advice, data-based investing advice, the real thing?

    What’s stopping us?

    Wall Street has not covered itself in glory. That much is certainly so. But I would far prefer to spend my time helping middle-class investors come to a better understanding of the realities than castigating Wall Street. It’s more healthy to direct your energies to positive purposes than to negative ones.

    Personal Finance Bloggers have influence in this world today. It wouldn’t take too many speaking out to turn this ship around. Within six months, we would be looking at the economic crisis in the rear-view mirror.

    It hasn’t happened yet. But that doesn’t mean that it is never going to happen.

    Rob

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