Why Spotting Bubbles Is Harder Than It Looks

Tree caricature from South Sea Bubble cards
Image via Wikipedia

Consistently predicting the future cannot and does not happen. The experts you see in media telling you what will happen next are never the same experts. Human beings fall prey to these pundits because we seek assurance of our future.

Can you spot a bubble?Ever since 1841, when a Scottish journalist named Charles Mackay published the book known today as “Extraordinary Popular Delusions and the Madness of Crowds,” the answer has seemed clear. If you watch carefully for signs of euphoria, you can sidestep the damage when markets go mad.

But bubble spotting isn’t as simple as Mackay made it sound—even, it turns out, for Mackay himself. Investors should always guard against the glib assertions of pundits who claim they can detect bubbles before they burst.

It’s also a reminder that expecting policy makers to predict the future by popping “bubbles in the making” is probably a bad idea.

Although plenty of people claim to have seen bubbles in hindsight, determining when enthusiasm morphs into euphoria is an inexact science at best. Consider today: With the global financial crisis lingering, but initial stock offerings like Groupon buoyant, is the stock market a bubble? When ATMs dispense gold bars, is gold a bubble? When some of the biggest bond investors say they are willing to buy Treasury bills at negative yields that lock in losses, are government securities a bubble?

History is full of examples of how no one can consistently predict the top or bottom of any market.

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