investment bubble australia

What is an investment ‘bubble’ and what can you do about it?

KnowHow founder Bushy Martin talks about investing in the new age of illusion and expands on the ‘investment bubble’ faced by investors in the wake of the pandemic.

[Bushy Martin talks in detail about the emerging asset bubble on the Get Invested podcast. Listen to part 1 and part 2.]

Are you hearing so many contrasting and conflicting opinions that you’re totally confused and just not sure what you should and shouldn’t be doing?

Does fear tend to dominate your underlying thoughts and emotions? Is there a sense of FOMO or ‘Fear Of Missing Out’ on the rapidly expanding boom times that we’re currently experiencing, mixed with fears that it may all coming crashing down around our ears overnight, due to another unexpected global shock?

Are you experiencing an insidious undertone of fear that’s quietly colouring your outlook and your actions? Particularly in a world that just doesn’t seem to make any sense – a world that seems to have gone crazy because what is actually happening seems to be the opposite of, or at odds with, what we expect to be happening – a world that seems to have separated from reality, where what is going on seems to defy all logic and reason?

If this is how you’re feeling, then join the club – you’re in good company.

So I thought I’d try and help you make some sense out of the madness, so that you can alleviate some of your anxiety by starting to get a better understanding of what is going on, why it is going on, and grasp an understanding of what it all means and what can you do about it, now and in the future, to both protect your position and take advantage of the inevitable opportunities that always accompany periods of great change and uncertainty.   

First, let me describe a very rosy picture of where things are at:

After a period of radical uncertainty and rapid change, things are going well. The government has spent massive unheard of amounts of money on stimulus packages to encourage spending and restore confidence. The middle class are comfortable and have come through the pandemic unscathed. Technology is continuing to take off and make new advances.

The central bank has dropped rates to historic lows and the government has borrowed millions to build infrastructure and create jobs and has begun buying bonds, which is code for printing money, so there’s lots of cheap money that is easy to get sloshing around in the economy. Prosperity and wealth are becoming the new normal and everyone is investing. The stock market and other investment asset values are soaring higher and higher to record levels.

Interest rates have been lowered by the central reserve bank to historic record lows, so you’re losing money by leaving your savings in the bank, and because lending rates are so low and loans are easy to get, its seen as better to borrow very cheap money on margin to invest in shares and other money market vehicles, because everyone is getting in on the action and no one wants to miss out, which results in share and stock prices and other investment vehicles climbing even higher.

Stock prices that normally trade at a long term average of 17 times their earnings are now trading at over 30 times their earnings with some popular companies trading much higher. And all this growth is attracting lots of new investors who have never invested before and know very little about what they’re investing in. They’re investing their savings and borrowing against their home so they can invest quickly in growing popular opportunities that everyone else is investing in because they don’t want to miss out. Everything is booming and the happy days are here again.

Now do you know what period of time I was actually describing? Was I describing the current emerging post pandemic roaring 2020s? No – you might be surprised to hear it’s not today I was talking about. I was actually describing what life was like during the roaring 1920s after the global Spanish flu pandemic – over a century ago. And interestingly, it very closely mirrors the times we are currently in. It sounds equally applicable now as it did then.

And do you know what followed it? The Great Depression of the 1930s. Now I’m not trying to scare you here, not by any stretch of the imagination, because we’re a lot smarter and governments and central banks have the proven ability to manage the economy through challenging times as they proved following the GFC and COVID-19. But I’m wanting you to become aware, to open your eyes to see what is really happening. so that you can take advantage of the times we’re in and the times that may be coming.

As I’ve said on many occasions before, quoting Warren Buffet, ‘What we learn from history is that we don’t learn from history’. And perhaps even more appropriate in today’s context is Winston Churchill’s immortal quote, that ‘Those that fail to learn from history are doomed to repeat it’ – the key words here being ‘fail to learn’. Because I keep hearing that our times are unique and unprecedented – that ‘this time it’s different’ (which is always a massive alarm bell), but the reality is that what we are going through has happened many times before over the dim distant past – the only difference is that the present is wearing new clothes.

What is happening right now in the world of investing?

Impacted sectors

On the one hand, the global COVID crisis has resulted in economic woes for most nations and continues to threaten overnight lockdown and shutdown instability despite the beginnings of the vaccine rollout, resulting in high unemployment and a reliance on ongoing government stimulus to prop things up. Many sectors of the economy, like tourism, hospitality, travel and bricks and mortar retailing, continue to struggle for survival, while others have benefited from the rapid change in circumstances, like home deliveries, game makers, home gym equipment, home improvement hardware and of course, zoom video meetings.

But while the overall economy has suffered financially, investment and asset markets have been experiencing soaring growth after the initial knee-jerk reaction and overnight correction to the coronavirus that occurred early in 2020.

Investment behaviour

In recent months we have started seeing some crazy investment behaviour. It appears that every man, woman, child and their dog is getting in on the action. And I always get nervous when everyone from the Uber driver to the local barista or the check-out attendant is bragging about what shares or crypto they are buying and how much money they are going to make. Instant ignorant investors, or should I say gamblers, acting purely on others of unfounded opinions is dangerous territory. 

Everything appears to be pointing to an emerging over inflated asset bubble, and eventually all assets bubbles pop. It’s just a matter of when, and how big the resulting correction will be.

So why is there this massive disparity and widening gap between struggling economies versus booming financial asset and investment markets? And what does it mean to you and your investment? And what can we and should we be doing about it?

An investment bubble

Let’s start by determining if we are actually experiencing a bubble. A bubble is an economic cycle that is characterised by the rapid escalation of asset prices and market values. So a bubble, in an economic context, generally refers to a situation where the price for something — be it an individual stock, a financial asset, or even an entire sector, market, or asset class— exceeds its fundamental value by a large margin in a relatively short period of time.

So let’s begin by having a look at what is happening in the US Equities markets, as it represents over 60% of the value of the global equities market. So, if the US Stock Exchange has a cold, the rest of the world immediately starts sneezing.

One of the measures that is commonly used to assess the relative value of a stock or share index is the price to earnings ratio, or P/E Ratio. In simple terms the P/E Ratio measures the current share price against its future earnings per share. A high P/E Ratio means that a company’s stock may be overvalued or that investors are expecting high growth rates in the future. A higher P/E ratio shows that investors are willing to pay a higher share price today because of higher growth expectations in the future.

Now, the long-term average P/E Ratio is about 17. Simply put, a P/E ratio of 17 means that the current market value of the company is equal to 17 times its annual earnings. In other words, if you were to hypothetically buy 100% of the company’s shares, it would take you 17 years to earn back your initial investment through the company’s ongoing profits.

Looking at the US Stock Market S&P 500, which combines most of the individual company shares, the current P/E Ratio is over 34, which is up over 52% from just a year ago and is 77% above the modern era average.

As an example, Amazon’s current P/E ratio is 73. Against this backdrop, Elon Musk’s company Tesla has literally rocketed to a P/E Ratio of over 1,100, with its share price surging over 665%. And Tesla has surged more than 20,000% since it first went public in 2010. Apparently, Tesla has become not only the most valuable car company in the world but also more valuable than all of the other car companies combined. Now while Tesla is producing great electric cars, even the high-flying front man Musk has publically tweeted that Tesla’s stock price is ‘too high’. So P/E ratios are well above their long term averages and certainly by this measure the share market in the US and many other countries is looking very expensive.

Does this all sound overvalued? Clearly the current P/E ratios are an indication of a stock market that is trading way over its normal value, with many companies appearing to be way overvalued. By this measure, and many other industry measures, the US Stock Market and many other stock markets that are trading at or near their all-time highs – including portions of the Australian market – certainly appear to be entering a bubble.

Enter the influence of mass perception investing and the age of illusion!

The Bubble Triangle: marketability, money and debt, and speculation

Bastardising the old looks like a duck analogy, if it walks like a bubble and talks like a bubble, then it probably is a bubble. And to add some science to this, lets apply the current investment market position to the great framework detailed in the book Boom and Bust by William Quinn and John Turner, who go through a global history of financial bubbles to create a simple triangular model, appropriately dubbed the Bubble Triangle.

Quinn and Turner’s study of over 300 years of bubble history reveals that for there to be a bubble, there are three necessary conditions that need to be met that make up each side of the triangle: These three conditions are: marketability, an abundance of money and debt, and speculation.

Marketability is the ease with which an asset can be bought and sold – bubbles can’t happen unless assets can be easily traded. Money and debt provide the fuel for the bubble, encouraging investors to reach for yield or borrow to buy assets. Speculation is the investment strategy of buying assets you expect to rise in price in the short-term, hoping to make a quick profit. During historical bubbles, novices and newbies have often become speculators.

Are these necessary conditions present today in the stock market? In a recent article the authors penned in the Cambridge Blog – the answer is a resounding Yes.

Firstly, Marketability is clearly evident as stocks and shares are easily accessed and traded, thanks to zero-commission brokers like Robin Hood and other free share trading, online platforms, algorithms and AI-robotic trading systems which have all combined to amplify and accelerate trading activity.

On the second side of the Bubble triangle, Money and Debt access fuel is super abundant due to near-zero interest rates, record levels of quantitative easing (which is code for printing money) with the US Government apparently printing 40% of the total amount of greenbacks that have ever been existence in the last 12 months. Increased access to money and debt has been further fuelled with other extraordinary stimulatory measures, including the 1.9 Trillion Dollar Biden package, the 2.2 Trillion Euro package and Australia’s $320 Billion big stimulus, which is equivalent to 16% of our Gross Domestic Product or GDP – and this is double that of the UK on a per person basis. All of these government instigated measures have pumped bucket loads of cash into the economy at large, a big portion of which has been invested in investment assets.

And finally, we consider the third Speculation side of the triangle. Let’s defines Speculation as people who buy investments regardless of the price they’re paying, with the attitude that valuation is irrelevant – you just buy an investment because it’s going up. This has certainly been evidenced in a significant increase in stock market momentum since the pandemic crash in March 2020. So, it appears that we are seeing clear signs of active speculation. This is backed up with clear anecdotal evidence that many people are giving up their jobs and becoming day traders or selling properties so they can speculate the house on cryptocurrency.

In summary then, it is clear that all sides of the bubble triangle are present to provide the necessary conditions for a bubble.

The external spark

However, for a bubble to happen, there needs to be an external spark. Sparks for historical bubbles either came from major new technical innovations such as electrification or the internet, or more commonly, changes in government policy. These sparks are difficult to foresee. In most cases, these sparks initially have a significant effect on the real value of assets. The internet, for example, was a really transformative new technology that revolutionised the economy and ushered in a new generation of spectacularly profitable firms. But by 1999 and 2000, speculation had driven internet stock prices to a level that even the potential of the internet couldn’t justify.

A major potential spark for a current bubble occurred as the response to the global pandemic in March last year, when central banks used substantial quantitative easing (read printed massive volumes of money) to arrest a stock market crash and underpin the economy. Since then, after a short knee-jerk dip, stock markets across the developed world have risen sharply, leading many commentators to suggest that stock markets are in a bubble. However, rapid price rises may be a rational response to the realisation that the authorities are effectively underwriting assets including the stock market. Just like during the dot-com bubble, however, this logic can only carry so far, especially when short term share traders start buying shares on borrowed margin just because they’re rising and a flood of first time novice investors are piling money into the market for fear of missing out – or what is commonly referred to as FOMO.

Investment bubble indicators

So, against the Bubble Triangle framework, all of the signs suggest we’re transitioning into a bubble.

Let’s consider some other investment bubble indicators. According to a recent article by Traceview Finance, there are three ways to identify stock market bubbles. Firstly, look for signs of FOMO. The ‘fear of missing out’ is often the primary and psychological engine that drives market fads into the stratosphere until there are virtually no more buyers or greater fools to continue the ascension. Secondly, an investment becomes normal conversation material – bitcoin is a classic example that is on everyone’s lips. And thirdly, the market fundamentals no longer seem to matter.

Expanding on these Traceview finance article observations, psychology and human behaviours (including irrational greed), coupled with high-frequency computer or algorithmic trading, sometimes cause certain asset classes to become widely overvalued and deviate from the true, underlying value.

Just like people who may not be ‘true fans’ like to jump on the bandwagon of successful sports teams who rarely lose, bubbles form when the crowd of investors (often newbies) pile into and hype up a certain stock or asset class such as Bitcoin until the fad ultimately ends, and the value plummets back to a more realistic level.

So, how do they think you can you tell if your investments or certain sectors are in a bubble that is at risk of bursting?


Greed and a ‘get rich quick’ mentality are often two negative human behaviours that can contribute to investors bidding up shares or assets to the point where there’s nowhere left to go but down.

Most well-informed, seasoned investors have a diversified portfolio of shares, ETFs, mutual funds, and bonds that generate long term average returns between 6-12% a year, depending upon the diversification.

Chasing returns

So while steady returns historically generated by a broad-based index fund have proven to build substantial wealth over the long-term, most novice investors chasing a market fad would scoff at the idea of making ‘only 10%’ on their money. And for Bitcoin aficionados, a 10% move could be in a single day during the height of the craze. This mentality, and a mass of new and inexperienced investors needing to achieve vastly outsized returns, is an obvious sign of a bubble forming.

Non-traditional investors

While traditional investors are often partially to blame for participating in behaviours that could result in a bubble forming, one of the biggest signs that a particular share or asset class is showing ‘bubblish’ tendencies is when non-traditional investors suddenly become instant overnight experts
and begin pushing what could be seen as a new market fad.

When inexperienced ‘investors’ with no prior market experience suddenly come out of the woodwork advocating that crypto and marijuana shares are the best places to put your money purely on the basis that they have doubled or tripled their money in a short period of time, which is exactly what is currently happening, then this is a sure sign you could be looking at an emerging investment bubble.

If there’s no other basis for making an investment other than recent price increases, and this fact is driving the price up based on the greater fool approach where you are relying on a greater fool paying more than you have, chances are you could be looking at an overvalued asset class that is ripe for a price pullback.

So how does FOMO on huge gains cause bubbles?

When no more demand exists for a particular stock or asset, the price will naturally fall until either buyers pick up the shares at discounted prices or panic ensues and an even more severe drop occurs. Generally, if there is real value in the underlying business, the price will be too cheap to ignore on a pullback. Buyers will then swoop in to take advantage of the lower levels.

Conversely, if there is not a whole lot of value in the business and the price has been inflated by novice investors and trend-followers for no rationale reason, there will more than likely be a mad rush for the exits. This fire-sale results in the bubble ‘bursting’ – which is what happened with crypto a few years ago.

Normal conversation material

Traceview’s second bubble indicator is when an investment becomes normal conversation material. Unfortunately, the vast majority of people have absolutely no interest in following the investment markets on a daily basis – let’s face it, all of that can be very boring.

As a culture, one of our unspoken rules is to avoid ‘money-talk’ and finances in general conversation. Therefore, one of the biggest indicators that an asset class is overvalued, occurs when everyone who does not have traditional investments or doesn’t follow the market regularly suddenly becomes a market expert on a particular investment.

For example, if the Uber driver you meet or the local bartender begins to tell you to buy a marijuana stock or particular cryptocurrency because of how much they have made in a very short period of time, chances are there is a bubble in that asset class and pure euphoria and gold rush fever is the driver of the price increase – not the underlying fundamental value of the business or asset. 

Look for obsessive media airplay

Another sign that the value of an investment asset has gone up beyond its true worth is when news organizations begin running stories highlighting the rapid increase in value. When the nightly news begins running specials highlighting the epic run up in the value of Bitcoin, there’s a good chance this could be contributing to the craze, because news organizations rely on viewers and will only air what they think will bring in the biggest audience. So, they’ll often pull stories that will be popular for the average person. During booming investment market bubbles, everyone suddenly becomes aware of the financial markets and news sources will cater to this sudden demand for headline grabbing financial news.

Another sign of sudden popularity occurs when completely new classes of financial products are created by financial firms around emerging investments such as ‘cannabis plays’ or ‘cryptocurrency ETFs’. These are further signs that there’s a significant likelihood that there’s just too much hype in these industries for you to be investing in them at a good price.

After all, the primary focus of these financial firms is to make money, so feeding off the frenzy is logical.

Fundamentals no longer seem to matter

Traceviews third sign of an investment bubble is when the fundamentals no longer seem to matter.

In general terms, the value of any business can be determined based on the cash flow and earnings that it will produce for its remaining life. Generally, companies that are in the growth stage of their lifecycle will receive a higher valuation from investors compared to more mature or declining businesses. This is because, as the business grows, its earnings and cash flow also increase each and every year, which justifies the higher valuation. While it is perfectly reasonable for valuations for growth-oriented businesses to be higher than the average company in the market, sometimes bubbles form in these industries that are new and growing or disruptive and taking market share in a particular segment of the market.

Too much credit too soon

Often, the company in a particular growth or trendy industry will have extremely high revenue growth but deepening, unsustainable losses and no proof that they can become profitable. While this is not a guaranteed sign that the business is doomed for bankruptcy, as virtually every successful and now mature company has operated at a loss at some point in their history, losses cannot be sustained in the long-term.

If investors don’t require the company to grow responsibly and simply bid up the share price because of revenue growth and the industry is new and hot, the fundamentals might not reflect the true value of the business. Eventually, investors may decide they have made enough money on the inflated stock price, sell their positions, and the value will drop like a brick.

Prices inflate beyond the fundamental value

As we touched on earlier in my discussion about price to earnings ratios, when the price of the asset increases rapidly and goes well-beyond what the fundamentals and future earnings would justify, the stock or asset could be in bubble territory.

Companies that are in new, emerging industries and are losing money are often the places that fad investors look to capitalize on big returns. In order to capture the gains, they’ll have to jump off the sinking ship before everyone else heads for the lifeboats. Otherwise, they risk losing everything along with everyone else when the bubble inevitably bursts. If the fundamental financial story of the company doesn’t align with the market value, chances are that investors are too excited and the future prospects may be overexaggerated.

Irrational exuberance

Much of this sentiment can be captured by what Nobel Prize winner and successful economics and equities author Robert J Schiller termed Irrational Exuberance in his book of the same name that was published in the run up to the dotcom crash of the late 1990’s.

Irrational exuberance is unfounded market optimism that lacks a real foundation of fundamental valuation, but instead rests on psychological factors. Irrational exuberance has become synonymous with the creation of inflated asset prices associated with bubbles, which ultimately pop and can lead to market panic. So let’s break down irrational exuberance.

Irrational exuberance is widespread and undue economic optimism. When investors start believing that the rise in prices in the recent past predicts the future, they are acting as if there is no uncertainty in the market, causing a positive feedback loop of ever-higher prices.

It is believed to be a problem because it can give rise to bubbles in asset prices. But, when the bubble ultimately bursts, investors quickly turn to panic selling, sometimes selling their assets for less than they’re worth based on fundamentals. The panic that follows a bubble can spread to other asset classes and can even cause a recession. The investors who get hit the hardest — the ones who are still all-in just before the correction — are the overconfident ones who are sure that the bull run will last forever. Trusting that a bull won’t turn on you is a sure way to get yourself gored. 

Herd behaviour and epidemics

Of particular relevance to our current environment, Shiller discusses his views on epidemics and herd behavior. He says that as humans, we rarely think independently and tend to do things simply because somebody else has done it. Not surprisingly, this is known as herd behaviour and investors fall prey to it. People are so influenced by others that they override their opinions when they hear that a majority of people have different opinions. Shiller evidences the experiments conducted by Gerard and Deutsch that prove that even rational humans believe that the majority is always accurate when compared to their own individual opinions.

For instance, if a man is asked to choose one restaurant between two restaurants with absolutely no information about them, he will simply choose one of them randomly. However, if another person is asked to do the same and he sees the first person entering one restaurant, he is more likely to enter the same restaurant just because he saw another person doing so.

The COVID Catalyst

From where I sit, global economic responses by governments and central reserve banks to the pandemic has created the perfect storm for the widespread accessibility, acceleration and amplification of investment asset price booms in most parts of the developed world. And this all boils down to the forced creation of two key things – lots of extra time and money.

In governments’ well intentioned attempts to stave off or minimise any recession or depression resulting from the forced sudden shut down and lock down of the economy, which they have very effectively done in Australia, they have poured billions of extra dollars into the hands of all and sundry in an understandable attempt to promote spending on goods and services to preserve employment and incomes.

At the same time, many have been left twiddling their thumbs at home, with the internet being their only connection to the outside world. So what do you do when you’ve got more money and lots of time on your hands? Yes, some spend it on home purchases, some pay down debt, many more save the money that they can no longer spend on going out or going on holidays, and a lot start investing it in appreciating assets, or speculating in high-risk but high-potential-return instruments like cryptocurrency, or gambling it on online casino and betting on game sites – all in the hope of getting rich quick.

Why? Because dropping interest rates to as low as they can go in order to reduce the cost of meeting loan repayments, both for the government, companies and individuals, means that you’re actually losing money and going backwards if you leave it in the bank, once the impact of tax and inflation is taken into account.

This has particularly hit the large and growing number of retirees who have seen their income plummet where they have been relying on interest and dividends. In addition, superannuation funds with massive warchests are forced to move monies into riskier investments in the hope of higher returns.

In combination with a relaxation in lending laws, easier access to much lower cost loans also means that we are much more likely to borrow money to leverage into everything from cars to properties to shares and other investment instruments, crypto included.

This rare combination of widespread access to lots of extra low-cost dollars and historically low cost, easier to get loans, together with lots more time to do something with it, has resulted in a rush of no cost or low cost leveraged investments, especially in tradable financial instruments via zero fee platforms like Robin Hood.

Impact on Australian and American borrowings

In Australia, the ratio of household spend to income has more than doubled in recent years from 104% to a high of 212%, according to the OECD Data revealed by finder.com.au. This means if the average Aussie earns $80,000 net, they are spending just under $170k a year. And according to the latest Corelogic figures, Australian household debt levels have increased substantially over the past thirty years, with the ratio of household debt to annual disposable income rising from 68% in June 1990 to a recent peak of 188.5% in June 2019. Since June last year, the ratio has reduced slightly to 185%.

While many other developed countries have seen a decline or ‘levelling out’ of personal debt since the 2008 Global Financial Crisis, Australia’s debt levels have continued to increase. As a result, Australia is now reported to have the fourth highest personal debt levels in the world, with the average Australian household owing $250k with total national consumer debt of $2 Trillion dollars.

On the positive side of this, the majority of it can be defined as good debt, with roughly 56% going to home loans and 37% to investments. That’s a total of 93% of our personal household debt being spent on potential wealth-creation. This compares to the American ratio of household spend to income at 112%. The average household debt in America is $145,000 with total consumer debt sitting at a record high of over $14 Trillion USD according to the Motley Fool report.

Interestingly however, due to the significant drop in loan interest rates, repayments have been kept at manageable levels. In Australia a recent AMP.NATSEM report shows that the typical ratio of debt interest repayments to disposable household income is sitting at around 6%. This compares to the average American who currently spends under 9% of their monthly income on debt payments, which has dropped down 1% from 2019 due to drops in interest rate relief, according to figures quoted by The Motley Fool. These high debt to income ratios means that an increase in interest rates could have serious economic consequences.

However, the central reserve banks have repeatedly made it clear that they will do whatever it takes to support the housing market and to ensure that low interest rates will remain in place until the country returns to full employment and inflation returns to the target range. Many industry commentators have projected that this will mean that rates will remain low for at least the next three years, with others forecasting that current rates will be with us for the next decade. 

So reflecting on all of this, by any measure we appear to be moving into a potential bubble.

What to do in an emerging boom bubble

So if you are looking to invest now, then you basically have three options:

  1. Buy into the bubble
  2. Short the market
  3. Adopt The Maradona Strategy

Let’s break these down by drawing again on the great work borrowed from Ramin Charles Nakisa on Stock Market Bubble Investing.

Buying into the bubble

Famous and successful equities investor George Soros says that when he sees a bubble forming, he rushes to buy, adding fuel to the fire, and he says the only way to avoid investors blowing up these bubbles into ever bigger bubbles is for regulators to step into the market to cool demand, which is in alignment with what Dalio also indicates in his debt cycle stage analysis.

So Soros says it’s rational to buy into a bubble, which makes sense if it’s at the beginning or early in the bubble phase. Now as an analogy some people have likened markets to a beauty contest, where if you want to choose the winner you don’t actually want to find the person you consider the most beautiful; you have to find the person which other people are most likely to consider beautiful, and that means you have to understand how other people think.

In this regard, it’s worth considering Jim O’Shaughnessy’s take on this, where he says that to be a good investor you have to understand human psychology. Now one of our cognitive biases in the way we think is that we tend to overvalue low probability but big payoffs – in other words lottery tickets, but you still take part because of the incredible payoff that you could get if you do win. Whereas we tend to undervalue high probability events, so for example an asset which gives you lower payoffs but with a higher probability is less attractive to us than it should be.

Now if you understand that, then suddenly it makes absolute sense for people to overpay for speculative assets like Tesla shares or crypto or gold where there’s a potentially very large payoff, but it comes with a very low probability of success. Given this probability weighting that’s built into our minds, it explains why some investors take a large undiversified position in skewed securities… so it does actually make sense for people to buy into a bubble because they can see this potentially very high payoff, even though they realize that most people lose money during one of these bubble episodes, particularly the ones that come late into the game that buy at elevated overvalued prices.

Short selling the market

In this approach you are effectively betting that the value of a share is going to go down and you make money on the difference in opening entry price and the lower exit price. Short selling is a fairly simple concept — an investor borrows a stock, sells the stock, and then buys the stock back to return it to the lender. Short sellers are betting that the stock they sell will drop in price. The difference between the sell price and the buy price is the profit you make. But I need to stress that this is a very risky investment approach, because if the price of the share goes up instead of going down,
then you can incur unlimited losses that could take you out of the game, and we all know that the long term trend of most share or indexes is up.

That’s why passive investing without trading too much and just buying equity or indices does so well as markets drift upwards. So if you can’t time the market correctly, and let’s face it we have to be honest with ourselves because most of us can’t time the market or detect a bubble reliably, then you’re probably going to lose out by going short in the market now. And in my humble opinion, unless you’re a sophisticated investor with a finely honed trading system or you get a sophisticated investor to do the work for you, the first two strategies of buying into a bubble or going short on an individual share are akin to giving a stick of dynamite and a box of matches to a toddler. As a conservative long term investor, I just wouldn’t do it after I spent a couple of years day trading many years ago.

In addition, there is no question that short term trading and price movements are heavily manipulated by the big traders who have intimate intuitive experience, the top hyper speed trading technology, very deep pockets and direct access to the media to creating price moving stories, so they’ll eat small part time inexperienced traders for breakfast and suck up your hard money like a vacuum cleaner.  

The Maradona strategy

This is my favourite approach. Now I don’t know a lot about soccer, or football as it’s called in other parts of the world, but famous Argentinian player Diego Maradona reportedly kicked the greatest goal ever. Past Bank of England governor Lord Mervyn King likened his appropriate approach to describe monetary policy by banks, where he described how Maradona ran 60 yards right from his own half through the English half and he beat five players and he scored a goal. But what was truly remarkable is that he ran in a straight line – so how was he able to beat five players by running in a straight line?  

Well the answer is that he used psychology – the defenders reacted to what they thought Maradona was going to do, which is to swerve to the left or the right ,so his way to beat them was to overcome their expectations and to run straight for the goal. So in this fashion, the way for most people to win in the case of an emerging bubble market is to completely ignore the fact you’re in a bubble at all and don’t do anything differently or try to be fancy.

This long term buy-and-hold strategy is how most sustainably successful investors approach the markets. What may seem very odd is for investors to deliberately choose inactivity as a virtue. This means that you don’t look at your portfolio on a daily basis – you just buy equity and leave it for decades and you’re likely to get a very good outcome. Of course there’ll be bubbles along the way so you can be opportunistic and buy more equity after a crash, but predicting whether we’re in a bubble or reacting appropriately and timing our entry and exit from trades is almost impossible. So, for most people, the best thing to do is absolutely nothing. Although it may sound strange doing nothing, it is actually a pretty good strategy and it works for a lot of people as long as you don’t sell when equity markets crash. For most people that’s going to work pretty well over the decades in which they’ll be investing.

If you already have investments and you bought them with a long term hold in mind and you still have years before you need the cash, then your option is easy – just ignore the noise, do nothing, wait and stick to your original plan. Getting caught trying to time the market and pick tops and bottoms is a fools folly that just about always ends in tears and is likely to cost you tens of thousands in lost opportunity while giving you a lot of unneeded stress and anxiety.

As I say in the Freedom Formula, good investing is boring, its like watching paint dry or grass grow, but if you really need excitement then go to the casino or the races and see how you go.

Finding stability with property investing

If you’re an Australian property owner or investor with a considered, long term approach, you need not worry about a bubble going bang. Australian property is one of the safest investment assets, and if you play the long game instead of rolling the dice, you’ll continue to enjoy long term growth while riding out the occasional and expected corrections that will impact the market from time to time.

Bushy talks in much more detail about the emerging asset bubble on the Get Invested podcast. Listen to part 1 and part 2.

Want to Know How you can build wealth in uncertain times with the help of leading, qualified experts? Talk to the team at KnowHow, now.

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