Stock Market Bubbles
5 min read
If you study stock market bubble’s, they tend to follow similar patterns based on the psychology of the bubble participants. Are we in the middle of one of the biggest stock market bubbles of all time? We most likely are. When it will actually end, no one knows but based on history the aftermath of the bubble will be long and painful.
The 1st time I ever experienced a stock market crash was at a very young age in 1987. My birthday falls at the end of October and I can still remember the coverage on in the background of my family birthday party. The 1987 Crash was violent and sudden like a storm but then it passed, and the markets suffered no real long-term damage. In fact, that event set up a nice multi-year bull run.
The 2nd market crash and the first bubble I experienced was the Dot Com bubble and bursting of that bubble in 2000. Leading up to March 2000, I was day trading stocks in college. Easy money is made in a bubble bull market, you do not have to really know anything other than “buy”. Ultimately, most of those traders end up losing everything when the market does finally top out and then collapse.
From peak to bottom, the Nasdaq experienced an almost 80% drop. That kind of market bubble and mania should teach lessons. For a short time, they do but the next bull market comes, or the next bubble forms and we forget about those lessons and complacency sets in. Between fear and greed, bubbles form and bubbles pop.
Not too long after the dot-com bubble crashed, there was another boom and bust market cycle created by the housing bubble. This bubble may be related to the dot-com bubble. Hedge funds, banks, and insurance companies caused the subprime mortgage crisis. Demand for mortgages led to an asset bubble in housing. When the Federal Reserve raised the federal funds rate, it sent adjustable mortgage interest rates skyrocketing.
As a result, home prices plummeted, and borrowers defaulted and asset classes across the board took severe beatings. This created the need for massive intervention and stimulus by the government and the federal reserve which brought on a 11-year bull market fueled by the Fed and Debt bubble.
March of 2020, we got to see the opening act of what will ultimately be an enormous bubble that will burst sometime which will cause dramatic stock market declines.
This was at the tail end of a bull market that lasted 11 years, the longest in modern history. This bull market was birthed from the dot-com bubble bursting with low interest rates and a flood of cheap money that had to go somewhere so it chased asset prices up. But was the party really over?
On Monday, March 9, the Dow tumbled 2,014 points, or nearly 8%, a record-breaking event. Measured in points, this was the worst one-day drop in the Dow’s history! However, the worst was yet to come. On Thursday, March 12, the Dow lost a jaw-dropping 2,352 points, a 10% drop, setting another record.
There were strong indications we were witnessing the beginnings of a bear market. The extreme volatility continued, getting worse by the day. On Monday, March 16, the Dow plummeted by an insane2,997 points (12.93%) –not only was this the largest one-day point decline, but also this collapse was a bigger percentage drop than the 12.8% decline on the infamous Black Monday in 1929, nearly 90 years ago, marked by historians as the day the Great Depression began.
However, the Fed came fighting back with lower rates, more stimulus and more cheap money and that has to go somewhere. The rally has lifted markets in a remarkably short period of time, but the stock market surge isn’t an unprecedented event. Past bear markets have seen stock market bounces of similar magnitudes, and historical bear market rallies can last a long period of time, years even.
As the bubble continues to inflate, it will inevitably pop, since the growth is unsustainable. Only the needle or the trigger event is missing for the market to crash or bubble burst. A stock market crash wipes out significant savings and wealth in the economy. This negative wealth shock has the potential to reduce consumer spending as people lose confidence in the future of the economy. The combination of real and psychological effects from major declines in stocks can be devastating for the real economy.
When investors believe a stock price will jump the next day, they rush in masses to buy the stock, which creates more demand for the stock. These self-fulfilling expectations can take place in the market for any asset or commodity and leads to what economists call a speculative bubble, where crowd psychology plays a more important role than the fundamentals of the company.
What comes up most always come down…
Even in times of market crashes, down years or even lost decades, there are always times of rallies, bounces and upswings. Even though the market looks like it did little to nothing over X period of time, quite the opposite actually is occurring with volatility and violent swings in both directions. In these times, it would be nice to sit out the down years and participate in a % of the up years avoiding those losses and there are financial products that can do exactly this.
Being at the end of a bubble for most will end up feeling like a weekend trip to Vegas. The expectations rarely match the end result and you are left broke and feeling hungover. The bigger the party, the bigger the hangover and this party has been raging for over a decade. The hangover will hurt.
Don’t get caught up with the rest of the gamblers, be smart and methodical with your approach to investing. While others may be emotional and irrational, having a financial game plan in place removes those kinds of pitfalls which leads others to self-destruction when the market turns, getting desperate which fuels the panic.
Getting real about your approach to investing and your financial future is the first step. Having a legitimate plan in place to grow and protect your money is the second step.
Learn how money works or keep paying the price for not learning.