The boys in the bubble

Thursday, September 24th, 2009 Hang Seng: -2.52%
Starbucks cafe, Zurich. One of the few places with clean air.

What a year so far!

Most indices have gained about 50% since March, and although sometimes we're running out of steam, the bull trend seems to continue, if less steeper.

Statistically, this is an interesting phenomenon. Profits like this occur about 0.5 % of the time in any 6 months period. To be more precise, the only time a rally of this magnitude happened before, in historical perspective, was in 1932-1933.

Now for completeness sake, there's been some talk of an upcoming correction, and certainly for some investors vertigo has set in. And recently I picked up the word bubble in the corridors of the human warehouse I work in, and someone with an utterly sick sense of humour described as an office, probably to get a building permit.

But back to the markets: what do we mean by a bubble?

In the financial world, many definitions are about but for want of a really good one, I prefer to go by a description who I partly nicked from a guy called Charles Kinderberger when he wasn't watching, and then edited it just enough for plagiarism to be ruled out.

The first stage is an event that causes (and, at prima facie, justifies) an increase in prices. Mostly, but not necessarily always equity. Think of the explosion of new technology that caused the dot.com (later: dot.gone) an oil boycott that sent prices per barrel through the roof in the seventies and, more recently, apparent spreading of the risk that caused the number of sub-prime house buyers to spin out of control.

In our case, this would simply be the re-bound of the near-collapse of the financial system, nothing more, and certainly nothing less.

The second phase is the cascade of easy credit that is pouring over your heads.
(Remember: "are you a home owner...?")

This would seem unlikely at the moment. But remember: the governments made credit easily available for banks, with the intention to pass some of it on to their clients. The banks don't do this, and park it somewhere safe instead, but that is besides the point now. It's there, just not for those who want it.

Then comes the hype.
Of course, after March we were all desperate to hear some good news. And for six months we have had plenty of it. The dynamics of the markets are mysterious, and sometimes it only takes one good news story to initiate a rally, just as a panic reactions sometimes can constitute a bear market in itself. And we so want to believe that all will be fine again.

Players on the sideline are now finally convinced that the worst is over and jump on the bandwagon. There's no stopping it now: we reached the next phase at full speed: euphoria.
After which comes the final stage: the crash.

I'm not sure if we're in a bubble now. If we are, then please realise two important facts about a bubble:

One. Every expert will tell you it's best avoided.
Two. At the same time, they spot the opportunity for short term gains, and think that they're smarter than the rest and pick the peak.

Now, of course, if we all think that, we might very well be in euphoria now.