Financial Freedom 101

What is a Bubble?

Investment bubbles have been around since the 1600s. A stock market bubble is a period of rapid growth in stock prices followed by a fall. Typically prices rise quickly and significantly, growing far beyond their previous value in a short period of time. When they fall, they do so quickly and the price falls twice as fast as it rises. Personally, I think Tesla is a bubble but my buddy Michael would disagree (lol).  A stock market bubble can either take the whole market down or specific sectors. Back in the 90s, we had the tech bubble where the whole tech industry was overvalued and fell rapidly in 2002, we could be facing another tech bubble in this specific period of time but only time will tell.

Typically bubbles occur when investors overvalue stocks, by misjudging the value of the underlying companies or trading based on criteria unrelated to that value. A lot of time bubbles get exposed by “FOMO” (Fear Of Missing Out) this causes investors to chase highly inflated asset prices because of seeing other people’s success. A stock market bubble is often formed when traders enter a  cycle of growth. As people buy certain stocks, they drive the prices of those stocks up. Other traders may see that growth and buy as well, hoping to profit off the gains. Eventually, traders aren’t buying the given stocks because they think the company is worth owning at that price. They’re buying in hopes of selling while the price is still high, and eventually, it bursts, and many lose. During the tech bubble, every company with a “.com” in their name got pumped like it was a current day amazon. I strongly feel that right now the same thing is happening companies like Uber, Lyft, and Zoom are all priced at valuations that do not match their accounting books.

Types Of Bubbles

Equity Bubble

An equity bubble is characterized by tangible investments and an unsustainable desire to satisfy a legitimate market in high demand. These kinds of bubbles are characterized by easy liquidity, tangible and real assets, and an actual innovation that boosts confidence. Two instances of an equity bubble are bitcoin in 2018 and the dot-com bubble back in 2002. When interest rates are at 0 like they are right now assets become priced at a premium which pushes are economy into a bubble that will eventually pop.

Debt Bubble

A debt bubble is characterized by intangible or credit-based investments with little ability to satisfy growing demand in a non-existent market. These bubbles are not backed by real assets and are characterized by frivolous lending in the hopes of returning a profit or security. These bubbles usually end in Debt deflation. causing bank runs or a currency crisis when the government can no longer maintain the fiat currency. Examples include the roaring 20s which led to the great depression of the United States housing bubble of 2008 and The corporate debt bubble that caused the quick COVID-19 recession is an example of combined debt and equity bubble that I still think is ready to POP.

Stock Splits and Bubbles

The stock splits of tesla and apple are clear warning signs that something is bound to happen in a negative way. The last time we saw companies do this was the tech bubble. Apple and Tesla are among the most popular stocks on Robinhood, and through the first half of the year retail investors have made up 19.5% of trading activity, compared to  14.9% a year ago and around 10% a decade ago. At the end of last year, Robinhood investors held 4.4 million positions in S&P 500 stocks; now they have more than 14 million.  Also, new E*Trade accounts have also spiked during the crisis with more than 250,000 additions in March, compared to less than 50,000 in the months prior. Retail investors clearly want in on the rally and have helped fuel the boom in Apple and Tesla. This can only end badly! After these surges, you can clearly tell tesla and apple are overvalued, but they do clearly dominate their industries. The rise of Tesla, which only delivered consistent profitability a few times and has been saddled at times with other problems, including liquidity, is more reminiscent of dot-com stocks. The stock is up more than 1,000% over the past year, and the surge over the last month has come on little news. At its current valuation, the company is more than twice as valuable as any other car manufacturer, including Toyota, Volkswagen, and General Motors, despite being much smaller by production. Apple, on the other hand, is a mature company whose days of high growth are far in the past. it has a p/e ratio of 40 and was more expensive than its ever been before the split. While investors have bid the stock up earlier in the year on hopes for a 5G “supercycle” of upgrades as well as a subscription bundle, the recent gains seem to have come predominantly from the stock split, much as they have for Tesla as well.

This rally can not last forever and correction will happen in due time. The higher it goes the more of a chance the bubble will implode. buying a stock because of a split is common but the disconnect between a split-induced surge and a fundamentally unchanged company means investors are paying more money for the same amount of value. That’s a sign that the game has turned psychological and euphoria over future gains, rather than improving fundamentals, which has become the primary driver of growth. The effect of the dot-com era which shows how a stock split driven market boom can end in an utter disaster has never been more prevalent to the times we are living in right now.

How do bubbles affect you?

Bubbles affect everyone within the country. Most of the time bubbles will cause a recession or a lot of people to lose a significant amount of money. The impact of economic bubbles is debated within and between schools of economic thought; they are not generally considered beneficial, but it is debated how harmful their formation and bursting is.  many believe that bubbles cannot be identified in advance, cannot be prevented from forming, that attempts to “prick” the bubble may cause a financial crisis, and that instead, authorities should wait for bubbles to burst of their own accord. Right now the fed is creating a bubble, Jerome Powell is printing money like its paper and he keeps pumping up the US stock market to avoid a recession, What goes up must come down the U.S dollar is getting weaker day by day and the economy is going to eventually burst into complete market turmoil. Political economist Robert E. Wright argues that bubbles can be identified before the fact with high confidence. The crash that follows after an economic bubble can destroy a large amount of wealth and cause economic destruction.  Not only can the aftermath of a crash devastate the economy of a nation, but its effects can also reverberate beyond its borders. The smart can profit off a bubble by avoiding greed. Greed kills. When people get too greedy it leads to huge losses and sell-offs. The dot.com stock market bubble and the more recent housing bubble are evidence of the stock market’s irrationality. … Investors start buying into these companies and the stock price goes up, which attracts the interest of new buyers. This in turn pushes the stock price higher, which kicks off a new round of buying.