How Do You Recognise A Bubble?

[silver surfer]

One of the constant claims of central bankers is that it's difficult to recognise a bubble until after it's popped.

How would you recognise and define a bubble? And is it time related, I once read that true bubbles (tulip mania, south sea bubble, 2000 tech boom) never last more than a few years at most, so at what point in time does a bubble stop being a bubble and become the "new normal"?

[stormymonday_2011]

One of the constant claims of central bankers is that it's difficult to recognise a bubble until after it's popped.

How would you recognise and define a bubble? And is it time related, I once read that true bubbles (tulip mania, south sea bubble, 2000 tech boom) never last more than a few years at most, so at what point in time does a bubble stop being a bubble and become the "new normal"?

Don't know but when you see the phrase 'a new paradigm' bandied about then it is time to sell, sell, sell.

Needless to say each brave new world comes with a brave new fraud to be perpetrated on humanity all wrapped up in a massive 'bezzle' as, John Kenneth Galbraith described it, which will sooner or later come undone with catastrophic results.

It will be interesting to see if QE ends up in that category

Edited December 28, 2014 by stormymonday_2011

[long time lurking]

One of the constant claims of central bankers is that it's difficult to recognise a bubble until after it's popped.

How would you recognise and define a bubble? And is it time related, I once read that true bubbles (tulip mania, south sea bubble, 2000 tech boom) never last more than a few years at most, so at what point in time does a bubble stop being a bubble and become the "new normal"?

When the central bankers stop throwing everything at it including the kitchen sink and it still exists when IR`s are at normal levels and all props have been removed

That would be my guesse with the emphasis on guesse

[winkie]

Easy....it is over stretched and the surface is thin.

[silver surfer]

So was gold a bubble a few years ago, was Tesco a bubble a few months ago?

[Bruce Banner]

One thing is certain, as far as the government and main steam media are concerned, a bubble is only a bubble in retrospect and until it bursts they all have their hands on the pump, pumping as if their lives depend on it whilst simultaneously denying it's existence.

[Wurzel Of Highbridge]

It's an interesting question.

I would define a bubble as time bound and includes the price doubling/quadrupling/growing exponentially then collapsing.

So what do we have in regards to UK house prices? Well I wouldn't call it a bubble like Irish, Greek and US property.

There I said it! UK house prices are not in a bubble, they are rigged by the government.

At one point they were in a bubble 2001 - 2007, the bubble is now propped up by lowering interest rates, forbearance and restricting new supply.

Even if prices fell by 50% over the next year I would not call it a bubble? Would you?

I would compare UK housing to oil where supply is rigged and there is strong demand.

[Bruce Banner]

It's an interesting question.

I would define a bubble as time bound and includes the price doubling/quadrupling/growing exponentially then collapsing.

So what do we have in regards to UK house prices? Well I wouldn't call it a bubble like Irish, Greek and US property.

There I said it! UK house prices are not in a bubble, they are rigged by the government.

At one point they were in a bubble 2001 - 2007, the bubble is now propped up by lowering interest rates, forbearance and restricting new supply.

Even if prices fell by 50% over the next year I would not call it a bubble? Would you?

I would compare UK housing to oil where supply is rigged and there is strong demand.

If prices fall by 50% over the next year I will consider the bubble to have burst.

[Killer Bunny]

I disagree that a bubble is defined wrt the price rise percentage/multiple. There can be 101 reasons why something goes up 10x and is not in a bubble.

The definition I like best is 'prices will rise because prices will rise'. That's a bubble. Can you think of any asset that fits that description of prices?

Edited December 28, 2014 by Killer Bunny

[200p]

Quantifying it.

If something doubles in value or halves in one year - then it could be a bubble or an extreme move that might be ending.

The Rouble has pretty much halved - this could be the new norm.

If a share price doubles in one year, it could be the new norm if it developed some new technology. It may double the next year, that could be the new norm OR it could be becoming a bubble if interest got over heated.

[Guest_northshore_*]

It's a bubble when you think you'd benefit from it popping.

[Roman Roady]

If it is too good to be true....it usually is.

Its been that way with housing since 2000.

[R K]

One of the constant claims of central bankers is that it's difficult to recognise a bubble until after it's popped.

How would you recognise and define a bubble? And is it time related, I once read that true bubbles (tulip mania, south sea bubble, 2000 tech boom) never last more than a few years at most, so at what point in time does a bubble stop being a bubble and become the "new normal"?

Keep it simple. Go with the Grantham/GMO definition/duration of +2 std devs v real trend. They've done the work so you don't have to.

From memory (you'll have to find a copy of his 2011 paper) their avg bubble duration was 3.5 years up & 3 years for the bust back to trend (the important element being the bust back to real trend). i.e. there's no such thing as a random walk or a new paradigm.

Edited December 28, 2014 by R K

[R K]

It's very much a personal taste thing the definition and must be according to the use it is being put.

I quite like Jeremy Grantham's definition.

https://www.creditwritedowns.com/2010/04/jeremy-grantham-on-bubbles.html

That is important. Remember that for the next line....

"At least 2 sd's above trend."

To a mathematical extent, his definition is self defining.

If you are looking at an annual figure over 40 years, then you are looking at a chance of 1/40 in any year. That is the same as 2.5/100. That is basically the same as 2 sd's in a Gaussian distribution. I think it is also interesting for being equivalent broadly to the duration of a Kondratiev Wave and the duration of an adult working life.

Now, I don't suppose he cares too much that it may not be a pure bell curve distribution but for the purposes of making a bet, it is probably a good enough approximation.

Importantly he includes 'above trend'. This means that changes to the money supply are automatically taken into account.

And for me, it is important for betting purposes that any definition is on a human timescale. Once every 40 years is a bit long for most people. But if you are looking at all asset classes, a bus will come along every few years at least.

EDIT: F*ck me, I took so long writing that RK snuck in first. But I would say my post is far superior in content.

If a bit windy.

Actually the important bit is that it isn't a gaussian distribution. It's fat tailed i.e. evidence is frequency > 40 years. Back to Taleb/Soros et al and their mandelbrotian/fractals

EDIT: I've also discovered that the couple of public copies I had bookmarked of his 2011 letter have been removed. Only the subs GMO copy is still available.

On this definition the US housing (securitisation) bubble is a dead on fit. It burst all the way back to and below prior real trend. UK housing bubble (2004-2007) still hasn't made it back to real trend yet due (presumably) to all the monetary and govt. interventions. London ofc has taken on an even more threatening life of its own.

Edit2: The bit that seems to confuse people on here is "real" i.e. inflation adjusted, not nominal and "trend" i.e. the long run trend of house prices to grow > rpi (since the war in any event)

Edited December 28, 2014 by R K

[stormymonday_2011]

IMHO it is a collective irrational state of mind as much as a question of asset valuations,credit exposure etc. That is why big economic busts are hard to call accurately in time. The metrics are often flashing danger warnings for months and sometimes even years before the implosion occurs. In the UK we are masters of delusion which is why we seem to keep our bubbles going longer than most other people. In fact we have built an entire national economic system devoted to creating and sustaining them.

[R K]

I disagree that a bubble is defined wrt the price rise percentage/multiple. There can be 101 reasons why something goes up 10x and is not in a bubble.

The definition I like best is 'prices will rise because prices will rise'. That's a bubble. Can you think of any asset that fits that description of prices?

Which asset class has gone up (in real terms) 10x and isn't in a bubble?

and what are (some of) your 101 reasons?

Edited December 28, 2014 by R K

[silver surfer]

There's a few definitions of a bubble, but there doesn't seem to be one that has universal acceptance.

A few seem to include the component of sudden and substantial price collapse, which I guess supports those who say you can't categorically identify something as a bubble until after it's popped, as the popping is a necessary part of it being a bubble in the first place. But there are things which have popped (i.e. fallen by 50% or more in a short period of time), like the Tesco share price, which I wouldn't describe as a bubble. The share price before it popped was rational on the basis of all known information, and the price after it popped was equally rational based on the new information.

I believe Minsky did some work on bubbles, and concluded there were markets that could be judged bubbles in advance of them popping, depending on the conditions of their financing. He had three measurement grades. Hedge Financing meant that the income flows from owning the asset were sufficient to pay back both principal and interest on a loan taken out to buy the asset. Speculative Financing meant the income flows would only cover the interest. And finally Ponzi Financing, which Minsky said qualified as a bubble, meant the income flows covered neither principal nor interest.

I guess by Minsky's definition much UK BTL activity today must be Speculative, and some will undoubtedly be Ponzi. But personally I'm not entirely convinced by Minsky's argument, for example using his definition would mean any and all purchases of gold (or non dividend paying shares...or tulips for that matter!) must be Ponzi Financing and therefore a bubble, as gold produces zero income, so can't service any component of a loan.

[silver surfer]

Which asset class has gone up (in real terms) 10x and isn't in a bubble?

and what are (some of) your 101 reasons?

Without digging around for the actual numbers you'll have to grant me some slack here, but the FTSE from 1980 to date has probably gone up 10x, but I don't think it's a bubble as the underlying price earning ratio today isn't that far away from it's long run average.

[Renewed Investor]

You can usually tell a bubble by looking at a chart of price moves.

If that fails, look for fundamentals and ask are they still valid. The stories used to promote whatever asset that is in a bubble tend to get more far fetched as time goes on.

Another sign is that when it becomes too easy for the average joe to make a good profit out of it.

back to charting though, I was discussing the Ruble on another forum and was using the Silver bubble chart as a comparison tool to point out that going long the USD against the Ruble was probably not a smart move at that point.

Here is the chart

Sadly I couldn't short this as my Broker removed the Ruble from their trading platform :angry:

[Renewed Investor]

This is what the USD/RUB looks like now.

[DarkHorseWaits-NoMore]

"It's different this time." Is another potential bubble forming indicator or top nearing alert .

[stormymonday_2011]

There's a few definitions of a bubble, but there doesn't seem to be one that has universal acceptance.

A few seem to include the component of sudden and substantial price collapse, which I guess supports those who say you can't categorically identify something as a bubble until after it's popped, as the popping is a necessary part of it being a bubble in the first place. But there are things which have popped (i.e. fallen by 50% or more in a short period of time), like the Tesco share price, which I wouldn't describe as a bubble. The share price before it popped was rational on the basis of all known information, and the price after it popped was equally rational based on the new information.

I believe Minsky did some work on bubbles, and concluded there were markets that could be judged bubbles in advance of them popping, depending on the conditions of their financing. He had three measurement grades. Hedge Financing meant that the income flows from owning the asset were sufficient to pay back both principal and interest on a loan taken out to buy the asset. Speculative Financing meant the income flows would only cover the interest. And finally Ponzi Financing, which Minsky said qualified as a bubble, meant the income flows covered neither principal nor interest.

I guess by Minsky's definition much UK BTL activity today must be Speculative, and some will undoubtedly be Ponzi. But personally I'm not entirely convinced by Minsky's argument, for example using his definition would mean any and all purchases of gold (or non dividend paying shares...or tulips for that matter!) must be Ponzi Financing and therefore a bubble, as gold produces zero income, so can't service any component of a loan.

All asset price rises have to be funded from real earnings even if the asset in question like gold generates none itself. If the total economy (capital and labour) is not generating sufficient wealth to support asset valuations or the debt payments on the credit created to buy the assets then sooner or later there is going to be a bust as the earnings are insufficient to meet the overall debt payment liabilities including interest. The only way to defer that day is to build a mechanism that enables credit liabilities to be rolled forward to infinity ( ie to allow old debt to be retired and replaced by new debt). QE is in some way an attempt to create this financial perpetual motion machine as it facilitates this process by backstopping banks balance sheets and allowing new credit lines to be opened. If the cost of borrowing is also reduced to zero in terms of interest rates theoretically there should never be a Minsky Moment since the condition of Ponzi finance (interest costs exceeding earnings) should never exist. Whether this is feasible in reality is another matter. Edited December 28, 2014 by stormymonday_2011

[HPCVrostus]

A peverse form of growth that is unsustainable.

[SNACR]

On the Minsky theme II think there's a strong case it's a bubble when people are borrowing money to buy into an investment/asset class and can only repay that borrowing if the investment performs as planned and would be unable to from their own latent earning potential.

In essence the speculators themselves do not even believe they are speculating.

[200p]

If one could create a speculating system where you make a profit from price point A to price point B, with risk approaching Zero, bubbles are of no of no consequence. In fact bubbles are a bonus because it reduces the time, t to approaching Zero, to reach profits, P.

https://www.youtube.com/watch?v=e6xz87ZUR1o