Bubble Trouble

Bubbles and bear markets are two separate and distinct things. Investors truly need to understand the differences. You need to understand which strategy to apply when, and not use a hammer when you need a screwdriver. Once you see the straightforward differences, you will know what to do.

One buys in a bear market and sells in a bubble. Those buying in bad markets made a lot of money. This approach avoids the pitfalls of market timing and uses knowledge of what you own or want to own to a maximum advantage.

A bubble results from a mania, meaning that either valuations or fundamentals are highly suspect or totally wrong, since emotions and perceptions have overwhelmed what is "real". It is better to run - meaning sell - if you recognize a bubble.

Some people wonder why the NASDAQ remained 3,000 points below its old year 2000 high for more than 5 years. They wonder why they had trouble making back their money that was lost in the year 2000 bubble. That is because they think of bubbles like bear markets and do not realize the incredible excesses of bubbles that have to be worked off. But the most important difference is the cause.

Bear markets are caused mainly by fundamental problems. The 5 main cause of a bear market are listed (see reference). It runs its course, and so does the poor market. Then things normalize. You buy into a bear market, since you get great prices on stocks; then stocks come back and you make more money.

Bubbles are not caused by fundamental events. It is investors themselves who create them. Investors come to believe some things that are not true or not rational and thus create a mania in a stock, in an industry, or in the overall market. If the mania goes on for a time, a bubble is created, and that builds until its inherent instability leads it to break.

One of the interesting differences between bubbles and bear markets is that in a bear market, there are plenty of bulls and bears. In a bubble, the few bears are drowned out by the loud and almost universal bullishness. This happened with the Internet, because a mania is normally caused by a belief in something that is supposed to be new and amazing, even though this cannot be proved.

It is natural to like momentum and money, but if investors have no disciplines and no sense of bubbles, then they are headed not for the big money, but for quite the opposite.

With bear markets, one wants to use buy and sell disciplines and buy when prices and fundamentals would dictate that.

There are market bubbles once in a great while, perhaps once in a life-time, but individual stock bubbles are more common. All bubbles have some similarities that concern how perceptions, emotions, and a lack of accurate information combine to set an investor trap.