The Bubble History
No bubbles, no troubles used to be a phrase used to describe the effects of carbonated drinks, but has since evolved to simply mean ‘no troubles.’ Perhaps quite apt when considering the global markets and the evolution and impact of bubbles on global markets, economies and investor capital.
There’s been plenty of debate over when the first economic bubble took place, the most widely accepted being Tulip mania, which hit the Dutch in the 17th century, whilst coin collectors may beg to differ, with the financial crisis of the 1620s referred to as Kipper – und Wipperzeit (“Tipper and See-saw”) being considered as the first, where the city states of the Holy Roman Empire debased currency to raise revenue for the Thirty Years’ War.
Whether the first bubble was the 1620s Kipper und Wipperzeit or Tulip mania is a separate issue, when considering the scale and impact of the respective bubbles, Tulip mania seemingly trumps the Kipper und Wipper period.
Since the 17th century, the number of economic bubbles have been on the rise and the 20th century will likely be remembered for the shift in investor appetite for investment that has perhaps transformed the bubble, in an era of globalization, to one that has far reaching ramifications to wealth and prosperity on a global scale. The bubble no longer developed by local investors but by global investors, making bubbles with significantly more trouble.
The Big Five
In history, while there would need to be an acknowledgment of many bubbles, there have been five that are generally regarded as the largest in history.
The Tulip mania bubble of the 1630s in Holland comes in at number 5. It may seem somewhat logical today that biodegradables have a limited period of intrinsic value, yet during the Tulip mania period, tulip bulbs were being sold at prices greater in value than that of luxury homes and for as much as 10 times the annual salary of a skilled craftsman. Prices were reported to have surged by as much as 10 times between late 1636 and early 1637, before collapsing by 99% in May of 1637, the price of a tulip falling to the equivalent price of a staple food item.
In the end, it was those hording tulips in what had become a control on supply who got their fingers burnt, panic selling as the price collapsed leading to the 99% slide, with people coming to the harsh realization that they had sold their homes for a plant. As is synonymous with bubbles, a depression followed, impacting not only those left holding the tulip, but even those who had managed to make profit from the bubble itself.
Next, came the South Sea Bubble of the 1720s. The South Sea Company, established in 1711 had been promised a monopoly on all trade with the Spanish colonies of South America by the British government. Expectations were that the company would see similar rewards as had been seen in trade with India. Shares rallied from a reported £128 to a whopping £1,050 within the first 6-months of 1720, before collapsing, the rally coming off the back of a lot of hype and directors of the company driving demand for the stock on the promise of great things to come. Following the collapse, investigations revealed deceit, corruption and bribery, leading to the prosecution of the instigators, including but not limited to company and government officials. Such investigations and prosecutions in the years that followed may have curtailed the bubbles seen since, with only the global financial crisis of 2008 eventually leading to regulators deciding to hold people accountable once more.
Japan’s real estate and stock market bubble of 1986 sits in 3rd place. Japan’s recession of 1986 was attributed to the Yen appreciating by as much as 50%, which led to the Bank of Japan entering into its era of significantly accommodative monetary policy that many argue remains till today. As a result of the Bank of Japan’s accommodative measures, the markets were flush with cheap funding, leading to land and stock values surging threefold in the late 80s. The bubble burst in the early 90s and Japan has never looked back. Asset prices collapsed in 1992, the Nikkei having fallen by as much as 50% by August 1990. While investors were left with heavy losses on the markets, the surge in non-performing loans hit financial institutions hard, leading to Japan’s ‘Lost Decade,’ banks’ exuberant lending habits shifting and for obvious reasons, not to mention a consolidation in the banking sector, which ultimately cost the Japanese government ¥9.3tn in an effort to recapitalize banks between early ’98 and ’99.
Coming in 2nd was the Dot.Com Bubble of the 90’s. There will not be many in the financial industry who are not aware of the Dot.Com Bubble, case studies on the subject prevalent in many economics course. The introduction of the internet ultimately led to levels of speculation on companies perhaps never seen before, with companies reaching valuations in the billions of Dollars at IPO, the majority of which were listing on the NASDAQ 100.
Speculative investment and insatiable appetite drove the NASDAQ from sub-500 levels to more than 5,000 over a 10-year period before the index eventually hit the wall, plummeting 80% between March 2000 and October 2002.
Unsurprisingly, a U.S recession followed and the NASDAQ failed to recover to 5,000 levels until January of 2015, though the global financial crisis certainly had a hand in the prolonged recovery to record highs.
Ranked 1st amongst the Bubbles of the past is the U.S Housing Bubble. The U.S House Price Index surged by almost 100% between 1996 and 2006, with the lion’s share of the increase coming in the wake of the Dot.Com recession. Fingers burnt on the NASDAQ drove investors into bricks and mortar, ironically in fear of another bubble on the main exchanges. The eventual collapse in the housing market led to the biggest economic slowdown since the 1930s and was aptly named the Great Recession. The surge in house prices coming off the back of a surge in demand, led to an unprecedented rise in household debt, with properties being mortgaged and re-mortgaged in a free-for-all of credit, with sub-prime lending synonymous with the collapse. In an effort to offload what became clear as an unsustainable credit environment, mortgage backed securities became widely traded, toxic mixed with non-toxic and rated by the agencies. Those holding the baby included Lehman Brothers, which came to an untimely demise, the U.S banking sector consolidation and tsunami that hit global financial markets that followed still leaving ripples today.
History should have taught investors an invaluable lesson, yet bubbles continue to form and grow and blow.
Why the bubble forms is certainly no mystery and there have been a plethora of studies on the psychology behind investor habits, but while the studies highlight the reasons, the IQ comes in second and the EQ takes over until it’s too late. The bubble forms through a sequence of events, starting with market speculation that an asset class is undervalued, supported by optimistic forecasts fueling speculative investments.
The media and the internet have become the perfect medium for such hype, creating a frenzy, with many a pundit giving their ten cents worth along the way, some more respected than others, but pundits nonetheless. The herd mentality then kicks in as the talk begins to circulate over dinners, on the golf course and in the work place. Who doesn’t want to be part of a group making a fortune in the markets? The bubble is not necessarily formed at the start of the rally, but once the market value and intrinsic value diverge by an illogical size. Investors will still jump in to catch the wave, with little regard of where values sit and whether more upside remains, driving values further until… EQ is replaced by IQ, the reports of overvaluations that were previously ignored, leading to panic and the ensuing sell-off, no single investor wanting to be the one left to turn out the lights. Ironically it’s the speculators that created the bubble in the first place who walk away with their winnings, leaving the rest to wallow in the ‘what might have been’, If only I had sold last week….
At the end of the day, while bubbles are driven by emotion rather than logic, the macroeconomic environment needs to be ripe for the pundits and speculators to begin searching for the new asset class to blow. After all, investors tend not to be overly optimistic during economic downturns.
The Next One?
So, are we heading for another bubble with plenty of trouble?
The economic environment certainly has improved and monetary policy remains particularly accommodative compared with history, the only question being where is it forming and how to avoid it?
There is some debate over the next bubble, but one that springs to mind is U.S student loans, which looks to be entering into a crisis. There is an estimated $1.5tn in student loan debt out there, no small amount by any stretch of the imagination. Delinquencies have been on the rise in the post-Great Depression era, student loan debt now the worst performing loan sector in the U.S economy. The numbers on delinquencies and arrears have been confusing, some blaming the U.S Department of Education for sweeping the problem under the carpet.
Revised figures on the student loan market point to loan delinquencies moving towards 50% across U.S colleges. To make matters worse, forecasts are for student loans outstanding to accelerate to over $3tn by the mid-2020s. If the delinquency rate hits even 30%, the bill to the U.S taxpayer will not only be of substantial proportions, but with the tax payer having taken little to no risk at all. Wage growth in the U.S remains moderate and, while labour market conditions have improved since the global financial crisis, starting salaries are just not what they used to be, while college fees continue to rise. It certainly sounds like a bubble…
The student loan bubble certainly looks ripe and has all the makings of an implosion, but one wonders whether we will soon be hearing of a Trump Bubble. The Dow is sitting just shy of 21,000 having sat at sub-18,000 the day before the Presidential Election. The promise of reforms and government spending have driven the rally and, while earnings may have beaten expectations, more investors are jumping on the band wagon. At what value will logic prevail? A market crash and a student loan implosion is something few are talking about. After all, with all the bulls, there have to be some bears and in the end we all become bears, it’s just a matter of time.