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Asymmetrical Bubbles
Submitted by Lance Roberts of STA Wealth Management,
Just recently Nobel Prize winning economist Robert Shiller warned that the U.S. stock market and Brazilian property market were areas of concern. Specifically he stated:
"I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets that could end badly.
I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable.
Bubbles look like this. And the world is still very vulnerable to a bubble."
Bubbles are created when investors do not recognize when rising asset prices get detached from underlying fundamentals, which I showed is currently the case in "The Market In Pictures."
However, just recently the Mercenary Trader blog reminded me of George Soros' take on bubbles.
"First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. The degree of distortion may vary from time to time. Sometimes it's quite insignificant, at other times it is quite pronounced. When there is a significant divergence between market prices and the underlying reality I speak of far from equilibrium conditions.
I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, 'As long as the music is playing, you've got to get up and dance. We are still dancing.' Eventually a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.
Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions."
The chart below is an example of asymmetric bubbles.
Soros' view on the pattern of bubbles is interesting because it changes the argument from a fundamental view to a technical view. Prices reflect the psychology of the market which can create a feedback loop between the markets and fundamentals. As Soros stated:
"Financial markets do not play a purely passive role; they can also affect the so-called fundamentals they are supposed to reflect. These two functions, that financial markets perform, work in opposite directions. In the passive or cognitive function, the fundamentals are supposed to determine market prices. In the active or manipulative function market, prices find ways of influencing the fundamentals. When both functions operate at the same time, they interfere with each other. The supposedly independent variable of one function is the dependent variable of the other, so that neither function has a truly independent variable. As a result, neither market prices nor the underlying reality is fully determined. Both suffer from an element of uncertainty that cannot be quantified."
The chart below utilizes Dr. Robert Shiller's stock market data going back to 1900 on an inflation adjusted basis. I then took a look at the markets prior to each major market correction and overlaid the asymmetrical bubble shape as discussed by George Soros.
There is currently a strong belief that the financial markets are not in a bubble despite much evidence to the contrary. However, it is likely that prices are currently driving fundamentals particularly given the artificial interventions of the Federal Reserve which is something that I discussed back in March in "There Is No Asset Bubble?"
"The speculative appetite combined with the Fed’s liquidity is a powerful combination in the short term. However, the increase in speculative risks combined with excess leverage leave the markets vulnerable to a sizable correction at some point in the future.
The only missing ingredient for such a correction currently is simply a catalyst to put 'fear' into an overly complacent marketplace.
In the long term, it will ultimately be the fundamentals that drive the markets. Currently, the deterioration in the growth rate of earnings, and economic strength, are not supportive of the speculative rise in asset prices or leverage. The idea of whether, or not, the Federal Reserve, along with virtually every other central bank in the world, are inflating the next asset bubble is of significant importance to investors who can ill afford to, once again, lose a large chunk of their net worth.
It is all reminiscent of the market peak of 1929 when Dr. Irving Fisher uttered his now famous words: 'Stocks have now reached a permanently high plateau.' The clamoring of voices that the bull market is just beginning is telling much the same story. History is replete with market crashes that occurred just as the mainstream belief made heretics out of anyone who dared to contradict the bullish bias."
The Mercenary Trader blog imparted some excellent words of wisdom in this regard:
In other words, you don’t have to be theoretically correct in your reasoning. You just need to have the right positions on at the right time. If you are in this game to win, then it is not about being right, but making money.
Yet at the same time, as a general rule you want to be theoretically sound if at all possible… because if your portfolio is anchored to a foundation of false beliefs, or not anchored to anything at all, that increases the likelihood of getting your head handed to you.
And thus, for traders especially, the ideal is to have the best of both worlds:
The ability to maintain general theoretical correctness, i.e. the chops to recognize a false trend for what it is, coupled with the flexibility and the means to profitably exploit false trends regardless, while keeping risk under control.
There are at least three levels to the game:
- That which is real
- That which is believed
- The market’s reaction to both
And so we would argue that, right now, it is more important than ever to understand the nature of false trends, feedback loops, bubbles and the like — and the proper means of handling them all.
Does an asset bubble currently exist? Ask anyone and they will tell you "NO." However, maybe it is exactly that tacit denial which might just be an indication of its existence.
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As bubbles increase as a result of fiat expansion and other counterfeiting measures, the bubble will burst not because of "sentiment" changing, but, because 1.2% GDP growth has not contributed the collateral that ought to be commensurate with the bubble. The available collateral - pyramided in so many ways through derivatives - is diluted. As both debt and M rise, the value of real collateral available goes to zero. There is no collateral to cover! That, imho is the essence of a "bubble".
The biggest bubble of them all is China.
"China is a massive asset bubble"http://www.planbeconomics.com/2013/05/muddy-waters-research-china-is-mas...
Ask yourself why bubbles are always marked with exponential rises. An exponential (as a transcendental function) is non-polynomial. It has an infinite number of positive derivatives. That means that every market play based upon derivatives increases. This attracts leverage such as futures, options, leveraged options, margined options, etc. The longer it goes the happier and more confident everyone gets ... until some action kills the whole thing.
Wait until the next Housing Bubble bursts.
In addition. I'm seeing so much crappy construction it's crazy.
2x4's and 2x6's that's been sitting out in the rain and not dried out then stuck into walls, bubbly/scaly/flakey concrete from rain damage when pouring it, poor drainage around the home sites ...you name it and it's out there.
Why? Building too fast, hiring cheap/inexperienced workers, extreme cost-cutting, and so on.
Makes me wonder how long this batch of houses will last before they begin falling apart.
Best advice; hire a top-notch home inspector BEFORE you buy if you decide to take the plunge into that Housing Abyss.
You're no cheap bastard but a wise one. I have built my own house numerous times from trees i felled , skidded out with horses, seasoned in the shade and erected piecemeal. They never cost me much but have a value, if not a price. Building a house , like everything worthwhile takes a lifetime. Build it well and incorporate your mistakes.Fuck the bankers, mortgagers, insurers , building inspectors and tax assessors.
You're no cheap bastard but a wise one. I have built my own house numerous times from trees i felled , skidded out with horses, seasoned in the shade and erected piecemeal. They never cost me much but have a value, if not a price. Building a house , like everything worthwhile takes a lifetime. Build it well and incorporate your mistakes.Fuck the bankers, mortgagers, insurers , building inspectors and tax assessors.
I saw the same thing in the housing boom of the 80's, what a mess.
One sub-contractor had the 4X4's for decks on townhouses eight inches into the dirt, no concrete base/footing.
I told the head foreman over the development and showed him - you know - 20 people on the deck five years later and it collapses and kills someone(s)?
One thing to have a cracked wall, another altogether to have a deck collapse.
He said "Hmmm..."; he was pissed off but not sure he ever fixed it.
The MAIN ENABLER of sizable asset price bubbles is keeping the real asset price histories out of sight. For example:
http://www.showrealhist.com/RHandRD.html
These histories show "topping out & falling far down" examples, that dominate. "The sky's the limit" imagining for a future is NOT exampled!
Conpersons-in-control agree with me, which is why these histories are NEARLY NEVER seen.
Here's another big reason that these histories are nearly never seen -- they strongly suggest the dominance of the coming & going of irrationality. This is BAD advertising for the financial sector, so NO! Journalism is a four letter word ...
Throw in PTT intervention and if the govt wants it up....it hard to see the real break point
There is only so much wealth in the world. Eventually it will have to be shared even among those that have most of it. Unless wealth is created anew I would expect an end to the existing system. But I would expect the stimulus for the end to come from an authoritative action, such as war, before a total breakdown in the system. But today since the existing wealth is concentrated and most have a pretty good idea of who is holding it the old standby of nation against nation might not hold because all nations will go after those holding the wealth amd control over their lives. Those that are using war as a means to retain their control.
Side effects of globalism. We are all one and the elite are our enemies.
This not a bubble but the expression of the primary affect of unlimited debt: asset inflation. It will be confiscated in some way but not allowed to randomly burst.
The printings shall continue until moral improves.
ZH is a bubble of negativity concerning the markets, so I guess the printing will continue for a long, long time.
Sample size is too small to prove anything, this time it will be different.
Watch what happens tomorrow, three possible outcomes.
1-Taper- Bullish because we recovery now! ES shoots up over 1800 in a nanosecond; closes year over 1850.
2-No Taper- Super Bullish because QEternity!! ES shoots up over 1800 in a nanosecond; closes year over 1900.
3-Increase QE- Super Mega bullish 9000!!!!1 ES shoots up over 1800 in a nanosecond; closes year over 1950, possibly 2000.
Either way the market will be up sharply tomorrow. The chance of us closing the year below 1800 is basically zero.
kinda starting to look like bitcoins chart.
All of these examples are Pre-QE America.....it may have a different trend in Post-QE America.....