What About Bubbles?

I like bubbles. My grandchildren like them. Even my dog likes them. There is something fascinating l about them floating there in the sun. For just a moment.

There is scholarly research about bubbles. The complicated physics behind bubbles and foam. Not so much fun as knowledge.

Then there are investment bubbles.

I don’t like these bubbles, but they are fascinating to behold. From a safe distance that is.

Tesla and Bitcoins are arguably two today. What can we learn about bubbles and what can we do to avoid the consequences. As with everything else, begin with studying what has happened before and see if there are lessons there for the present.

Bubbling things

There are many. The Dutch Tulip Bubble, The South Sea Bubble, Bre-X, and the late 1920’s New York Stock Market are a few of them.

All of them share common themes.

  1. People are greedy, and seeking something for nearly nothing is a human failing.
  2. Each has a compelling story, often with a novel or romantic element. Gold, new territory, new industries.
  3. They are enclosed. The story does not rely on anything not already part of that story.
  4. People share the stories once they are involved.The future is sold as a fact
  5. People need very little actual, typically none, information to make, hold, and defend their decisions. The logical, internally consistent story is the fact.
  6. Some address things people fear. Failing health, governments, big business.
  7. For purposes of the story, all rely on the idea that the future is known.
  8. Each ignores both existing and developing competition

In may ways they are like a conspiracy theory. Any new fact can be subsumed into the existing story. Once a new fact cannot be subsumed, the collapse follows. Often well below real value.

Stock market bubbles

Because we are too smart to fall for tulips, right?

Bre-x was based on a fraud, yet it was a popular purchase until Lakefield Research, now SGS Canada, a local business, used their assay skills to prove the samples were phony. Immediate and total loss for those so unlucky as to have been caught up. Maybe luck is being nice.

The South Sea Bubble proves conclusively that you need not be dumb to lose your money. Issac Newton made money in the beginning and exited with a useful profit. However he came to believe he had quit too soon. Many of his friend were still in and doubled their money once more in just a few months. He reinvested his money together with borrowed money. The bubble broke and he lost everything.

In the 1920s radio stock was a thing. In 1922 alone there were 700 licenses issued for radio staions. All AM of course. There are about 4,200 100 years later. Radio was a big thing and everyone wanted to invest in it even though in the beginning no one saw how it could make money. Advertising as we know it was in its infancy then. Nonetheless, people bought lots of radio stock. On the novelty and story of it. There were 18 public offerings between 1923 and 1926. RCA came to be the leader. If you bought RCA in 1929 at $568 per share, you would have lost more than 97% of your money by 1932 and other stocks would have done worse. RCA survived and you could have broken even in 1954.

Being the business leader in a new sector guarantees little.

Word Perfect once dominated the word processor software field. Well over 50% of the market. It now has a 0.05% market share

Tesla relies on the idea electric is clean and we want clean. Of course if you count the cost to create electricity and recycle batteries, it might not be as clean as we think. Tesla is novel and the cars are both pretty and powerful. Attractive hero.

Tesla competes with well entrenched industries. Oil, auto manufacturing, service stations, auto parts stores, and the corner repair shop, are the cast of villians. We want to side with the hero agianst difficult odds.

Tesla has a good story and so long as you overlook the financess, a bright future. That is of course, the villians do not prevail and no new, better and cheaper technology comes along.

Bitcoin’s villain is governments and banks who want to remain in control. A decided underdog is sympathetic. The technology is new and completely obscure to nearly every investor. The product it replaces is universal. Currency. It promotes privacy and control. How you make money with it is obscure and no one seems to care. It is not quite money, but it has moneylike characteristics and everyone loves money.

The takeaway

All bubbles can be noticed and avoided. The trick is to use reason instead of emotion when assessing them. The old wisdom that if a thing looks too good to be true, it is, should hold. This time is different is occassionally true, but an investor will not count on that. Perhaps a speculator will.

As always there are enough seeming bubbles that succeed to draw you in.

Decide who you are as an investor. It helps make some decisions easier.

I help business owners, and professionals understand and manage risk and other financial issues. To help them achieve their goals, I use tax efficiencies and design advantages to acquire more efficient income and larger, more liquid estates.

Please be in touch if I can help you. don@moneyfyi.com 705-927-4770

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