As we continue to wade our way through the recession, people are looking at where we are and asking what happened. My personal opinion is that the current recession is largely a byproduct of normal moves in the economy over time but right now, we are still trying to figure it all out. One of the terms we hear a lot is the word, “bubble.”
I remember the good ol’ days when I was child and my parents bought me a bottle of bubbles. I would see how big I could make the bubble without it bursting. It was such a beautiful bubble as it got larger and larger but often times, the bubble bursts and the soap from the bubble got in my eyes and it stung. I loved the bubble until it ended up hurting me.
Sound like the financial markets? It should because this same scenario has played out numerous times. Remember the tech bubble? The Silicon Valley was where you were putting your money during the tech bubble because tech stocks were going through the roof. Then, as fast as tech stocks went up, they came back down. The technology bubble had reached its peak and soap ended up in the eyes of those investors.
A bubble in the financial markets is usually considered an overinflation not based on basic economic principals. In more general terms, something is going up fast and there is really no reason that it should be happening other than investors as a whole investing on the move. This could be considered inorganic growth. The problem with inorganic growth is that the market will always get rid of something that isn’t based on real factors. Bubbles always burst…always.
Let’s look at right now. Just like the human body flushes out something that is bad for it, so does the economy. The economy (represented by the collective minds of everybody in it) recognized that real estate had inflated in value without any real or organic economic factor so the economy set out to correct it. The same thing happened much more rapidly with oil. Some economists believe that the government is trying to prevent the economy from correcting the bubble with the Obama Stimulus Plan, TARP, TALF, and Band Banks which is only going to prolong the problems. You may not agree and should invest using your own convictions.
Next time identify a bubble, trade it but don’t invest in it. Don’t get greedy. Take some profits but stay disciplined in your diversification. The bubble will burst and if you’re not careful, your money will disappear along with the bubble.