Financial bubbles feel exciting until the busts devastate; trouble is that the two go hand in hand.
From a single stock to the entire stock market, Dutch tulips to American houses, Beanie Babies to cryptocurrency, a bubble can form around pretty much anything that can be bought and sold. It can be hard to spot a bubble from the inside, and devastating to be caught up in one.
In this week’s class, we learn the causes of bubbles with an example from history — it’s not tulips. We’ll examine bubble thinking and the mental biases that can exacerbate them. And we look at the lasting effects crisis (like a financial bubble bursting) have on the market, as well as the people who live through them. Here is a direct audio link.
Some timeless quotes on this topic:
“You cannot beat the market, says the standard market doctrine. Granted. But you can sidestep its worst punches.”—Benoit Mandelbot, The (mis)behaviour of markets: a fractal view of risk, ruin, and reward (2004)
“The problem with the world is that the intelligent people are full of doubts, while the dumb ones are full of confidence.”
—Charles Bukowski (1920-1994), German American poet and novelist
“Confidence is a feeling, which reflects the coherence of the information and the cognitive ease of processing it. It is wise to take admissions of uncertainty serious, but declarations of high confidence mainly tell you than an individual has constructed a coherent story in his mind, not necessarily that the story is true.”
—Behavioural Finance Danny Kahneman, Thinking Fast and Slow (2011)
“Investors accept in theory the premise that the stock market may have its recessions in the future. But these drops are envisaged in terms of the experience of the past ten years when the maximum decline was only 19 percent. The public is confident that such setbacks will be made up speedily, and hence that a small amount of patience and courage will bring great rewards in the form of a much higher price level soon thereafter.
Investors may think they are basing this view of the future on past experience, but in this they are surely mistaken. The experience of the 1949-1959 market – or of all bull markets put together – reflects only the sunny side of the investment. It is one thing to say airily that the market has always come back after declines and made new heights; it is another to reflect on the fact that it took 25 years for the market to reach again the high level of 1929, or that the Dow Jones Average sold at the same high point in 1919 as it did in 1942 – 23 years later.”
– Benjamin Graham, Excerpted remarks, December 17, 1959
