The Eight Characteristics Of Stock Market Manias

Tyler Durden's picture

From GMO's Edward Chancellor

The Typical Characteristics of a Stock Market Mania

1. This-time-is-different mentality. Throughout history, successive market manias have been rationalized with the argument that history is no longer a reliable guide to the future. Both the “new era” of the 1920s and “new paradigm” of the 1990s were marked by a “this-time-is-different” mentality. The same mode of thinking is evident again today. U.S. profit margins are currently at peak levels and the profit share of GDP in the United States is more than two standard deviations above its long-term mean (based on data going back to the 1920s). The U.S. profits dataset is the most reliably mean-reverting financial series available, claims Andrew Smithers of Smithers & Co. Most commentary, however, assumes that U.S. profits have reached, in Irving Fisher’s immortal phrase, a “permanently high plateau.” As John Hussman of Hussman Funds comments, “Believing that historical tendencies have evolved into a new paradigm will likely have the same results as playing leapfrog with a unicorn.” Painful.

2. Moral hazard. Speculative bubbles tend to form when market participants believe that financial risk has been underwritten by the authorities. The “Greenspan Put” appeared in the late 1990s after it became clear that the Fed was prepared to support falling markets but wasn’t going to act against the bubble in  technology stocks. Fed policy hasn’t significantly changed since then. Monetary policy in the aftermath of the financial crisis has aimed to put a floor under asset prices, encouraging investors to take on more risk. As a consequence, U.S. household wealth – comprising largely of home equity and stocks – has rebounded to a near-record level of 472% of GDP, nearly 100% above its long-term mean. Whenever a cloud appears over Wall Street, market participants have come to expect more quantitative easing and guarantees of perpetually low interest rates. The personnel may change at the Fed, but the Greenspan Put remains in place.

3. Easy money. Great speculative bubbles have generally been accompanied by periods of low interest rates. Greenspan’s easy money policies in the last decade inflated the U.S. housing bubble, along with numerous other bubbles around the world. Bernanke’s cure for the economy in the wake of the financial crisis has been more of the same. For more than five years, U.S. real interest rates have been maintained at negative levels. An avowed aim of the Fed’s quantitative easing has been to push down long-term interest rates in order to boost both the stock market and home prices. In particular, lowering the long-term discount rate has boosted the valuation of growth stocks.

4. Overblown growth stories. Another common feature of a bubble is the overblown growth story. We witnessed this during the Dotcom bubble, ad nauseam. In the late 1990s we were told that tech stocks were experiencing “S-curve” growth (which posits very rapid growth in the near term); investors were also encouraged to value the “real options” of Internet stocks from future income streams yet to be conceived. Many of today’s high profile growth stocks – operating in fields such as social networking, electric cars, biotechnology, and, of course, the Internet – have been boosted by similar wishful thinking. Just as there were serial railway bubbles over the course of the 19th century, Internet stocks in the age of Dotcom 2.0 appear to be experiencing what my colleague James Montier has termed a “bubble echo.”

5. No valuation anchor. The most speculative markets – from the 17th century Dutch tulip mania onwards – have been marked by the absence of any valuation anchor; when there’s no income to tether the speculator’s imagination, asset prices can become unbounded. Our electronic age has even come up with a digital version of the Semper Augustus tulip. The fact that Bitcoin – the best known among the dozens of competing crypto-currencies – soared by 5,500% during the course of 2013 is testimony to the strength of the recent speculative tempo.

Needless to say, most of the recent stock market darlings – Netflix, Facebook, Tesla, and Twitter – have little or nothing in the way of profits. Internet retailer, whose margins have deteriorated in recent years yet whose stock soared nearly 60% in 2013, is the poster child for a market that is more obsessed with growth than profitability.

6. Conspicuous consumption. Asset price bubbles are associated with quick fortunes, rising inequality, and luxury spending booms. Since the spring of 2009, not only has the Fed engineered a strong rebound in the level of household wealth, but the richest part of the population has enjoyed the greatest share of the gains. Luxury spending has surged globally since the crisis.

The art market provides an excellent barometer of the speculative mood, given art prices depend entirely upon what other people are prepared to pay. A bubble in modern and contemporary art, which was evident before the financial crisis, has returned. Last November, a sculpture by Jeff Koons – Balloon Dog (Orange) – fetched $58 million at auction, a record sum for a work by a living artist. The contemporary collector apparently isn’t fazed by the fact that this dog was one of five “unique” versions or that Koons himself didn’t produce the work by his own hand but had it made in a factory. The same month, a painting by Francis Bacon sold for $142 million, the highest price ever paid for any work at auction.

7. Ponzi finance. Manic markets are often marked by a decline in credit standards. In the last decade, subprime debt inflated the U.S. real estate bubble. The financial crisis may have had many unpleasant after-effects, but it hasn’t diminished the appetite for low quality U.S. credit. In fact, we have recently witnessed the lowest yields for junk bonds in history. The quality of debt issuance has been deteriorating. Last year, nearly two out of three corporate bond issues carried a junk rating. Last year, total issuance of high yield and leveraged loans exceeded $1 trillion. More than half of the 2013 vintage leveraged loans came without the traditional covenants to protect investors. The decline in the quality of credit has attracted the attention of Jeremy Stein, one of the more market-savvy Fed governors. Stein’s boss, Janet Yellen, has also expressed concern about the manic leveraged loan market.

8. Irrational exuberance. Valuation is the truest measure of speculative mood. There are other ways to take the market’s pulse, however. Most conventional measures of market sentiment have become very elevated over the past year. The IPO market in 2013 and into the first quarter of 2014 has become particularly speculative. New IPOs in 2013 rose on average by 20% on their first day’s trading (Twitter rose 74% on the day it came to the market last November). Nearly three-quarters of the IPOs, which were launched in the six months to March, produced no profits. A good portion of these profitless IPOs, in particular those of the biotech variety, hadn’t even got around to generating anything by way of revenue. They are story stocks, pure and simple.

Other sentiment measures have been telling the same story. The trading activity of corporate insiders is a reasonably good indicator of managements’ view on the intrinsic value of their companies. Recently, the ratio of insider sales to purchases has climbed to near record levels. Equity mutual fund flows – another commonly cited sentiment indicator – have also picked up lately, while household cash balances (as a share of total assets) have declined. Margin debt as a share of GDP is close to its peak level. Market volatility has been trending downwards, while the daily correlation of stocks – another useful gauge of the market’s fear level – has also come down.

* * *

And yes: we have all of the above right now, most of which in record amounts. So... buy, buy, buy.

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Hippocratic Oaf's picture

Paging Fonestar on item 5.


CheapBastard's picture

"There's never been a better time then now ... to get Butt Banged."

max2205's picture

Rigged or not...this rally is something to the Devils Tower....your eyes can't stop looking

fonestar's picture

Paging Fonestar on item 5.



ZH Snob's picture

it takes nothin' to make somethin'. 

we like to believe in magic wealth, and this fantasy is abetted and enabled by our wealthy role models, goverment and media.  avoiding this boozy bandwagon is seen as foolishness because that's how things seem when newspeak becomes one's point of reference.

NoDebt's picture

But if you constantly scream that it's a bubble that's proof it's not a bubble.  Therefore, nothing to worry about.  Buy moar stawks.

Or something.

McMolotov's picture

That nice man with the bowl cut has everything under control. Please do not worry.

dontgoforit's picture

Buy fish.  Eat well.

Stuck on Zero's picture

That's bullish for fish futures. Buy options on margin.  Go all in.


Grande Tetons's picture

9. Long Call Girl wait times. 

fonzannoon's picture

where else you gonna put money?

 - cnbc

Charles Nelson Reilly's picture

up Cramer's ass in hopes of him shi*ting out diamonds?

NoDebt's picture

Personally, Argentinian bonds.  Hand over fist.

What?  Why are you looking at me like that?

Comte d'herblay's picture

InTrade's offering of whether or not Pretorius gets LWOP?

Comte d'herblay's picture

InTrade's offering of whether or not Pretorius gets LWOP?

silverserfer's picture

not enough 401K $ soaked up yet, Some sheep like to be slaughtered. It makes them feel alive.

Lewshine's picture

"RISK" has been taken out of the market. Doesn't make any difference what happens, and where! In fact, the greater the risk of ___(FILL IN THE BLANK)___, the better to be LONG equities. Because the Fed will hit the pedal at max velocity if any threat remains - domestic or abroad that could influence their last bastion of deceit...Otherwise known as the US stock market, AKA: The US economy!!!

Hippocratic Oaf's picture

Let it sell off.

Fuck the banks.

PE is waaaaaaaaayyyyyy too high.

A correction of at least 25% is

That way, maybe, when CNBS starts talking 'fundamentals', someone may listen.

disabledvet's picture

"They end."

That's all anyone needs to know about these things.

Move along...

vote_libertarian_party's picture

uhhhhh....haven't this been the case for 5 years?

NoDebt's picture

You're not supposed to point that out.

McMolotov's picture

Yes. It works until it doesn't. And the longer it works, the more of us go insane.

HaroldWang's picture

And tomorrow's Super Tuesday! Line up and get yer free money, folks!

Balvan's picture

Not a bubble, unlike previous bubbles, this time majority of population is not even involved in the market.

dontgoforit's picture

Unfortunately, when the financial nuke goes off it won't matter if you've got 100 bars of gold, $50 million in cash and/or plenty of stocks, bonds, or anything else.  We all get irradiated.

Comte d'herblay's picture

It wasn't individual retail that caused the Panic of 2008.  IT was the Institutions.  

Retail is not a factor now either, so it won't matter.

J B T F D.

kurt's picture

They have the stock market and all index's running in a simulation in redundant locations in utah and colorado. They must have an intact mechanism to execute trades, mapped out in advance so they can keep draining the RUBES' money. It also facilitate the frauds in other sectors (see George Washington's latest post on ENRON 2).

We are well and truly fucked. See you at the dump. Fight you over that dessicated dog pelt and might have to club you to death. Per the UN we're supposed to eat more insects.

Tenshin Headache's picture

You forgot the most important one.


9. Endemic fraud and corruption

Georgia_Boy's picture

6. I live in a fairly poor city by coastal standards, and Benzes, Beemers, Lexuses, etc. are everywhere around here. It's like the new standard, it's beneath people now to drive a mainstream brand car. And when I go downtown on the weekends, lots of big touring motorcycles that had to have cost 35 or 40K. There cannot possibly be that many people around here who can afford these cars and still save any money.

Clowns on Acid's picture

What is this "save money" concept you speak of ? Does it have anything to do with mobile apps or winter weather ?

Itchy and Scratchy's picture

9. Institutional Selling  ..... Check

10. Retail buying ...... Check

DOGGONE's picture

Serial binging is evident, but showing it is BAD FOR BUSINESS.

Meatier Shower's picture


I don't want to hear anymore!

The season premier of 24 is on tonight!

AdvancingTime's picture


 Yes it is about charts and computer driven lust!  Damn the reports of ebbing growth and problems across the world, FULL SPEED AHEAD! Leap before you look! Do not wonder if we have become to complacent to the dangers before us as asked in the following article.

Rodders75's picture

BTFATH bitchez!

MedicalQuack's picture

You can add this as number 9 or a sub of one of the others and that's the case of "The Grays" as even the White House is living it with not being able to separate virtual values from real world values...the selfie of Obama/Biden cinched it for me and actually scared me. 

Are we getting jobs created to fix failing we got were a bunch of algorithms..Facebook being the most dangerous right now, like money out of thin air.  A million dollars to be "chosen" by Facebook for a silent video at that runs one day!  Look that one up, insanity, King Zuckerberg here? Look at this big companies like kids, oh let me spend my million first?

And here's "The Grays"....