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August 06 newsletterInvestment bubbles and crashes
Investment bubbles and the subsequent crashes go hand in hand. A bubble has been described as being "any deviation from fundamentals", or "an upward price movement over an extended range that then implodes" (Kindleberger).
The most recent crash following an investment bubble was, of course, the aftermath of the internet dot com party. The Dow Jones Index (measuring the big US stocks) rose over 150% from June 1995 (4,556) to December 1999 (11,500). If the Spice Girls weren't bad enough, we also had to endure watching the value of those US stocks then fall by a third (to 7,591 in September 2002).
In the 80s, we experienced big hair and the crash of '87. The NZX50 doubled between November 1985 (850) and November 1986 (1,682), before losing it all to sit at 941 in November 1987.
In the 70s, we had hippies and Muldoon. Residential property prices (in real terms) increased by around 20% in both 1973 and 1974, before stumbling by around 11% in 1975.
Are we in a bubble?
Any discussion on investment bubbles begs two questions. Are we in the middle of a bubble? And if we are, how can we ensure that we are protected from the "implosion"?
Bubbles are a curious thing. They seem to be identified as a bubble only after they have burst. Take the internet craze, for example. In hindsight, it was obviously a bubble. But, at the time, the value of shares was justified in the terms of the "new economy". During the bubble, the old ways of valuing an asset did not apply in the "new economy".
In my opinion, residential property investment is one potential bubble out there now.
There are two classic symptoms of a residential property investment bubble:
How to avoid the pain of a bursting bubble:
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Savings the old fashioned way of making money.