The Chinese economy, London’s real estate, Social Media companies, Tesla Motors. What is it with all people calling everything a bubble these days?
There are a thousand definitions for a bubble. Some say it is a huge trend you have not participated in. Others stick to a more conventional description – unsustainable valuation.
One of the purposes of free markets is to correct excesses. If you believe that something is a bubble, devise a plan to profit from it. Don’t just stay on the sidelines. There are several ways to participate:
1) You could become part of the momentum and help early short sellers to part with their money. George Soros loves bubbles: “When I see a bubble, I buy that bubble, because that’s how I make money”.
2) If momentum is not your forte, then short it and see where it gets you. Just because something seems overly expensive, it does not mean that it won’t become more expensive. Hundreds of money managers thought that the housing market in the U.S. was in a bubble in 2004. They ended up being right, but between 2004 and 2006, many homebuilders stocks quadrupled in value. You cannot afford to lose 300% of your clients money. Most will take it back, when you down 30%, so even if you end up being right, you might not even be able to benefit from it. Timing is of crucial importance when you bet against a bubble, because “the market could remain irrational longer than you could remain solvent” – as Keynes pointed out. You could wait for a technical breakdown and short the crap out of the bubble – some say that catching trend reversal are the most favorable risk/reward trades/investments. Keep in mind that the higher the potential reward for each unit of risk you take, the lower the probability that it will actually work. This is how financial markets work. If you could make 10 times your money in a deal, the odds are high that this deal might end up wiping our your entire investment.
3) Wait for the bubble to busts and they pick up the pieces at extremely low prices and sell them during the next bubble. Here’s the thing. You need leverage to create bubble. Financial leverage. Leverage is the main reason why when a bubble bursts, the market over-shoots to the downside and send asset prices to extremely low and some would call them “favorable” prices. Without a big bubble, you cannot have a big bust. And without a big bust, you cannot pick up assets at extremely attractive valuations. So stop complaining. As Peter Lynch likes to say: “ I don’t know what exactly causes big market corrections, but I know that the track record of most successful long-term investors would be impossible without them (the corrections”. To benefit from a bust, you need to have an ample supply of cash, because credit markets are often closed when prices are the lowest. People think in terms of capital preservation, not in terms of making more money.
Most people take the passive approach of side-lined viewers. Everyone has an opinion, but very few have an idea how to turn that opinion into an actionable plan. It is the trading and investing ideas that matter.
If you believe that something is a bubble, you could actually profit from it. Usually, people who point fingers and call something a bubble, do it for one main reason – to declare to the world that they will never put their money there and other people should do the same, because “it will end badly”. And you know what? Maybe it will. The financial history is full of booms and busts and actually both precipitate each other. Learn to live with it. Bubbles are not going anywhere. Neither are busts. But you could make a big difference in your life if you learn how to participate in them.
