How Long Can A Bubble Last Before it Ends?

An interesting article by AEI about the effect of collapsing oil prices on Russia explained that agricultural problems caused by Stalin took 60 years for the Soviet “bubble” to collapse.  Basically the Soviets needed to import grain by selling oil and when oil plummeted in the 1980’s that burst their system’s bubble. They simply ran out of money in November, 1991 and collapsed the next month. In my opinion this shows how a bubble can go on for a very long time, although technically a bubble requires a voluntary market instead of a transaction imposed by the government.

Madoff’s Ponzi scheme lasted perhaps 30 years until the crash of 2008 exposed him.

In 1986 GMO started a fund that bet on the decline of Japanese companies because the Japanese economy was starting to become a bubble. But it wasn’t until four years later that the bubble crashed. It had a PE ratio of 56 versus 44 for the U.S. bubble of 2000. (A fair PE ratio is 15, when it is below that it is time to buy).The problem with Japan is they had both a stock market and real estate bubble at the same time. Our 2000 bubble basically was a hybrid cash-based bubble where participants gambled with cash rather than borrowed money so after the collapse the successor companies were able to use the technological infrastructure to rebuild. Japan’s bubble was much more of a debt fueled bubble.

The U.S. bubble of 2000 was a hybrid of cash-based bubble and debt fueled because overall there was a great increase in debt but when a specific trade was placed to buy stock it was often done with cash. The way this worked is that a consumer would buy a home with a smaller than normal down payment and thus expanded his mortgage debt. He then had more cash left over after buying a home which could then be deployed into stocks. Contrast this with the U.S. real estate bubble that ended in 2008 where people bought homes with ten to one leverage. That bubble was far worse than the tech bubble.

Things that could make the current stock bubble burst would include increased periods of sideways price trends and then greater volatility which would cause some recent entrants to lose money and cause others to lose value compared to the high water mark, which might ruin their plans. This could make some participants decide to take some profits off the table and sell, thus tipping things over to a trend of an imbalance of sell orders. A crash in junk bonds may be the canary in the coal mine illness that precedes a stock crash. Junk bonds are equity-like in their nature but tend to have more efficient markets as they are less exciting and thus are less likely to attract irrational retail investors who overpay and create bubbles. Over-leveraged hedge funds that own these are likely to drop them quickly once signs of a crash materialize, thus triggering a rout. Then when junk quality corporations can’t get junk bond financing that could result in damage to these companies, thus hurting the economy and creating a climate for a stock crash.

Despite a weak economic recovery the real world of GDP and unemployment is slowly but surely improving. However, based on profit metrics such as the PE10 ratio the fair value for stocks is roughly half of the peak when the SP500 reached 2008 points, which means that stocks could drop to 1000 points for the SP500 even if the real world economy data such as GDP continue to grow at a modest pace. Investors need independent financial advice about the risks of a stock bubble lasting longer than normal. I wrote an article Increased debt fueled 17 year stock bubble.”.

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Don Martin

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