Bubbles Revisited

Oct 2019

There is no safety in following the crowd, since the actions of crowds invariably lead to stock price extremes that ultimately self-correct. For simplicity’s sake, imagine an investment approach that calls for buying all stocks that begin with the letter A and selling short stocks that begin with the letter B. If this “investing” scheme proves to be popular, stocks beginning with A will appreciate while stocks beginning with B will depreciate, in typical self-fulfillment fashion. In a true bubble situation, the popularity of “buy As and sell Bs” could grow rapidly, as initial results seem to confirm the strategy. Ultimately, stock prices for As will be driven way too high, while prices for Bs will become way too low. Then, at some unpredictable-in-advance moment, the bubble will burst, and prices for A stocks will plummet while prices for B stocks will rise. This general bubble pattern has played out many times in the past, and it will very likely play out similarly in the future. That said, it is amazing how short investors’ memories can be during the bubble-inflation process.