THE BIGGEST BUBBLES IN THE FINANCIAL MARKET

The last few centuries have given rise to various moments of irrationality in financial markets and their consequent effects on the world economy.

Despite having their own specifics, there are always characteristics in common. Greed, fear and excessive speculation, which make people to pay unjustifiable prices for some asset, far above its underlying value, out of fear of missing out on an opportunity.

The resulting price increase, however, is not sustainable. The result is a sudden and sharp collapse in prices, together with a trail of destruction of assets. An environment of irrational exuberance then emerges.

Although financial bubbles are not rare, often those involved do not identify them at the time they are happening.

They are often found only when they burst.

Sometimes they are triggered by inexplicable phenomena, such as the spontaneous tulip mania in Holland in the 1630s, or they are stimulated by manipulative actions by individuals or corporations, as in the case of the subprime bubble.

The fact is, when there are people trading irrationally, willing to take huge risks, we have a recipe for disaster.

Therefore, to help you better understand these situations and know how to differentiate them from market cycles, we have separated the main economic bubbles you have seen, explaining how they formed and from what way ended.v

WHAT ARE THE STAGES OF A FINANCIAL BUBBLE?

There are usually five stages in a bubble: displacement, boom, euphoria, profit taking and panic. On the move, a new product or technology gains the attention of more and more investors, or there is a period of low interest rates that drives investors to assets with the potential for higher returns.

As the boom sets in and prices rise, more investors enter the market out of fear of being left out. This leads to euphoria and prices soar.

Profit-taking occurs when investors start to fear that a bubble might actually be forming and some start selling to protect themselves from what they consider a crash. imminent.

This brings the final phase: panic. It occurs when the masses realize that the market is overvalued and rush to sell their positions at the same time, leading to drastic falls in asset prices.

HOW LONG DOES IT TAKE FOR A BUBBLE CYCLE TO END?

"The market can remain irrational longer than you can remain solvent.”

This is a quote often attributed to the famous economist John Maynard Keynes and reflects the reality of how long a bubble can last. As long as there are people willing to pay dearly for something, the market will remain bullish and this can last for years and years.

For example, some analysts claim that we are in a bubble in the US stock market, which has been on the rise for 12 straight years since the 2008 crisis unfolded.

Let's get to know the main economic bubbles already seen in the world.

TULIPS Mania (1634-1638)

Perhaps the most famous example of a speculative bubble is the “tulip craze” that hit Holland in the 17th century.

It is also one of the first recorded examples of an asset bubble, but what is known about it is very limited, with most of the knowledge about it based on rumors and leaflet extracts from the time.

At the time, the Dutch were known for their love of flowers and highly valued the tulip, obtained in the Ottoman Empire (Turkey) and used as a status symbol by high society in the mid-16th century.

Dutch collectors created a hierarchy of tulip varieties based on their species and colors, assigning values to each one.

This made them the object of speculation, initially among the richest and then by the poorest and middle-class families in the mid-1630s.

Increased demand caused the price of bulbs to soar and the market to reach its peak in late 1636 and early 1637, when flowers came to be worth more than houses.

People mortgaged their properties and industries to buy and then resell at higher prices.

In February 1637, as spring approached and the bulbs neared flowering, consumer confidence evaporated and the market suddenly crashed, driving many people into bankruptcy and plunging the Netherlands into an economic depression.

Labeling an asset a “tulip” sounds intuitive, in the prism of bubbles: they're embellishments, relatively useless, and easily mass-produced. No sane person would buy them at extremely high prices, unless in a time of bubble, when people are driven to herd behavior and act irrationally.

That's why tulips have become synonymous with insanity in the markets.

MISSISSIPPI BUBBLE

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The Mississippi Bubble, named after the French Mississippi Company, was a speculative stock bubble that took place in France, stemming from the dire economic situation the country was in at the beginning of the 18th century. By the time of Louis XIV's death, in 1715, the treasure was in ruins, with the value of the currency fluctuating volatilely, due to the wars the country had faced.

The standard norm in this situation would be to reduce government spending, but -- unfortunately for France -- the monarchy devised another scheme, along with Scottish economist John Law, who believed paper money was largely preferable to gold and silver coins. used at that time.

Law proposed the creation of a bank, the Banque Royale, and in August 1719 created a scheme in which the Mississippi Company would assume all French national debt and exchange it for shares in the company. Based on the expected earnings from the company, Law promised a 120% profit to shareholders. In return, the country should allow him the exclusive privilege to commercially exploit land in French Louisiana.

The proposal was accepted and soon Law's businesses in the Mississippi valleys flourished and the Mississippi Company held a commercial monopoly in the French colonies in North America and the West Indies. In one year, the stock price has risen 1900% and the value of the company has increased exponentially.

It turns out that, due to the continued increase in demand for the shares, and when the newly created French bank started issuing much more paper money in exchange for the gold and silver coin people deposited in it, inflation soared. Yes, money printing has always caused inflation.

The bubble eventually burst in late 1720, when the company's shares tumbled. People revolted, realizing that this was all orchestrated by John Law. This threw France into one of the biggest economic crises in its history.

During the same period when French speculators were raising the Mississippi Company's stock price, British speculators were buying shares in the South Sea Company. At the beginning of the 18th century, the economic situation of Great Britain was harmed by two wars that were taking place simultaneously, the Great Northern War and a war with France.

The government was increasingly dissatisfied with the service it received from the Bank of England, which had the authority to grant loans. So the newly appointed treasurer, David Harley, suggested the creation of a new company called the South Sea Company. It was created to convert £10 million of government debt (acquired during the War of Spanish Succession) into South Sea stock. In return, the company would receive annual interest payments from the government and the South Seas trade monopoly.

Despite their efforts, the company remained largely unprofitable, but the founders decided to keep it a secret, and between 1711 and 1720 they issued shares several times to consolidate their debt.

In addition, rumors spread about the company's profitability to make the stock price soar.

Meanwhile, seeing the success of the South Sea Company, several other companies began going public and the shares were offered to the public. But it all fell apart in 1720, and an investigation into the matter revealed that the founders had committed fraud along with several high-ranking officials. The market's first big drop came in August, when foreigners and other investors began to withdraw from the market. The scheme finally collapsed in early September, with shares falling 75% in four weeks.

Parliament conducted an investigation, corrupt politicians and businessmen were arrested and over 2 million pounds were confiscated from the directors of the South Sea Company.

As the markets crashed, thousands of people lost their money and this became known as one of the biggest bubbles in history, causing a serious economic crisis in England.

THE GREAT DEPRESSION (1929)

The real reason for the crash was the result of reckless speculation at a time when everyone was interested in entering the financial market, despite the fact that wages were low and consumer debt, like unemployment, was rising.

Even so, the stocks of several companies continued to give high returns for a while and the stock market was growing rapidly, making the whole scenario extremely fragile and risky. As soon as investors started to realize and worry about the unsustainability of the situation, they started to sell their overvalued shares and the whole system started to collapse.

A total of 12.9 million shares were traded on October 24, 1929, the day that came to be known as “Black Thursday” and another 16 million on “Black Tuesday”, October 29, 1929, leading the Dow Jones index falling more than 60% and destroying the wealth especially of those who had borrowed to invest.

This is widely considered the worst recession in the history of the industrialized world. It all started with a financial bubble, which led to the crash of the stock market in October 1929, leaving Wall Street in a panic and sending millions of investors into bankruptcy. The real reason for the crash was the result of reckless speculation at a time when everyone was interested in entering the financial market, despite the fact that wages were low and consumer debt, like unemployment, was rising.

Even so, the stocks of several companies continued to give high returns for a while and the stock market was growing rapidly, making the whole scenario extremely fragile and risky. As soon as investors began to realize and worry about the unsustainability of the situation, they began to sell their overvalued shares and the entire system began to collapse.

FINANCIAL AND REAL ESTATE BUBBLE IN JAPAN (1986-1991)

To combat the 50% appreciation of the yen, in 1980, the Japanese government started financial programs that offered monetary (currency offer) and tax benefits in the country. These measures, in turn, encouraged runaway speculation, resulting in skyrocketing stock prices and property values between 1985 and 1989.

Stock and property prices soared between 1986 and 1989.

At the height of the bubble, the grounds of the Imperial Palace in Tokyo - which cover just 0.4 square miles - were worth more than any other. real estate in California.

Realizing that the bubble was unsustainable, the Bank of Japan raised interest rates to try to deter speculation. The move, however, led to a stock market crash and a debt crisis as borrowers could not make payments.

The Nikkei stock market fell 50%, culminating in the bursting of the bubble and leading Japan into its "lost decades" of the 1990s and early 2000s.

The effects of the bubble and the deceleration that were installed are still being felt in the country.

BUBBLE OF SUBPRIME MORTGAGES (2008)

The 2008 credit crisis was triggered when big US banks had to take huge losses on subprime mortgages, which were loans made to people who couldn't afford these loans.

Before the crisis, banks provided cheap credit, backed by bonds that were covered by insurers' default policy. These bonds were securitized and sold in the market and appreciated due to the perception that property prices could only go up.

In addition, it was endorsed by companies such as Fannie Mae (officially the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp), who judged the health of the loans. When market conditions began to deteriorate and homeowners couldn't afford the mortgage payments, banks foreclosed on the bonds and the 2008 housing bubble burst, otherwise known as the subprime mortgage bubble.

This led to the bankruptcy of companies such as Bear Sterns - which was the first investment company to suffer a major blow in March 2008 -, followed by Lehman Brothers, which went bankrupt six months later.

In September 2008, stock indices plummeted and the crash had ramifications for economies around the world. Central banks then had to step in to bail out the financial system with programs such as quantitative easing (QE). A practice that continues today.

BUBBLE OF THE .COM COMPANIES (1995-2001)

When it comes to sheer scale and size, few bubbles match the dot-com bubble of the 1990s. At that time, the rising popularity of the internet unleashed a massive wave of speculation in new economy businesses.

It all started in 1997, when the widespread use of the internet paved the way for many startups in the field to launch an IPO.

As a result, hundreds of companies and technology have achieved valuations of billions of dollars as soon as they go public.

The Nasdaq index soared from a level below 500 in the early 1990s to a peak of over 5,000 in March 2000. A level that would only be reached again in 2015, more than 15 years later.

As prices soared, more investors as well as speculators entered the market. But the situation changed and reality began to appear. Many established companies have lost much of their valuations, while several smaller ones have had to face full closure.

The market began to collapse and, in total, tech stocks have dropped $5 trillion in capitalization since the peak. The NASDAQ dropped nearly 80% in October 2002, kicking off a recession in the US.

Some companies have survived and have become tech giants, including Amazon.

CRYPTO MARKET AND THE BUBBLES

As in other markets, cryptoactives are also subject to bubble moments. As we know, the vast majority of the 10,000+ tokens have no intrinsic value, their prices reflecting only euphoria and pure speculation.

Even Bitcoin, with all its value, can experience moments of irrationality on the part of investors. That's what happened between 2016 and 2017, when its price went from US$ 600 and reached US$ 20,000 in 1 year, rising more than 2,000%, then falling more than 65%. By early December 2018, the price of Bitcoin had bottomed out at $3,295, down 83% from the top, but the price has since made a remarkable recovery.

The blame is not on the assets, but on the irrationality of investors. Notice the indicator below, called the Rainbow chart, as the market showed signs of overvaluation in 2017. The price reached the red zone of “bubble maximum territory”.

It is currently in the middle region, in yellow.

Since there is no single system for identifying bubbles, past experience should provide the wisdom needed for investors to know when to stay away from an overheated market.

Technical Analysis indicators such as the RSI, which show moments of overbought, can be useful tools. However, there is no metric that works flawlessly, as the market can remain irrational for a long time.

Unfortunately, humans don't always act sensibly. With this in mind, it is likely that economic bubbles will continue to occur in the future. So you already know: if the price of an asset you're interested in becomes unreasonably higher than it's apparently worth, stay out. Invest strategically and with common sense, keep emotions under control and avoid rash decisions so you don't fall victim to bubbles.

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