Wednesday, 27 July 2011

Greatest Insanity

Have we ever wonder why assets prices are chase upward, sometimes off its true asset value, derailed off the course to reach record high price, which set the traders and investors to a jolly good ride, usually end with the crashing of the price downwards when people starts to realise that the price is way to high? Some experts called it the Economic Bubble, or you may call it the price bubble, market bubble, etc. While i call it the Greatest Insanity of Human Behaviour that destroy hope.

What is an economic bubble? If you google it out, you may get tons of simple explanation on these terms. some economists till date still can't explain the reasons for bubble to occur because every insanity has its own complex underlying explanations. Some can blame Hedge Funds and institutional traders for driving the asset to deviate strongly from their intrinsic values, while there will always a minority that may blame on the luck and timing. Whether is it luck, or experts in the field pushing it upwards, we have to take into account that all these are boil down human behaviour. Google it out and we will find that this behaviour is know as herd behaviour in stock market today. As quoted in the wikipedia, "Many observers cite these episodes as clear examples of herding behavior that is irrational and driven by emotion—greed in the bubbles, fear in the crashes. Individual investors join the crowd of others in a rush to get in or out of the market".

We can depict a scenario of stock market making higher highs. When stocks make new highs, experts can it the bullish market scenario when sentiment is high, and wealth are created as a result. When it continues to make new high, sometimes higher than its Net Asset Value (NAV) and Book Value (BV), we can also relate it to the fact that retail investors are come in to chase the price because of the herd behaviour theory. From these, the ingredient added are simple; Greed. "Fortune favours the Bold"; if you can recall from history, Alexander the Great did said before to his generals and his troops. This make sense to the point that investors make trade together with the crowd, greedy for more returns. Whether is it some collaborations of fund houses, or certain groups of investors decide to take profit for their expensive holidays, naturally the stock market halted and cannot move higher, same situations for currencies. Eventually, what goes up must come down, everything is just free falling the next day. This is the same situation we seen during 2008 before Lehman Brothers bankruptcy. The US stock market went crushing down and sent a wave of sellers into a frantic selling mode.

The next question is how many economic bubbles do we have since the born of the economy, or should i narrow it down to after industrialisation? There are a number of economic bubbles or asset bubbles that happened way back centuries ago. Of course some academic study will show the most famous asset bubbles of all time is the Tulip Mania back in the 16th Century. We living in these modern times have only witness the Internet dot com boom, and the housing bubbles in 2007 that were so destructive; almost bring down the whole world economy. There are also some small asset bubbles which were easily forgotten as it was recovered and did not do much of the damage. There are a couple more asset bubble story that happened, which were long forgotten. Lucky that i found a kind soul that able to gives a perspective on what is a bubble in 'layman' form for us to learn. Chris Martenson produced a clip which i will share with you folks. Remember to watch finish the 2 parts of the series.




                                                     *A great thanks to Chris Martenson

From his explanation, we can learn that economic bubbles does occur a number of times in history. The human behaviour will never change as we have seen from history till now whatever that had happened. To make things worst, derivatives were 'invented' to manage the risk, but only to see it has been 'abused' in the end; using it to make money rather than its original purposes of managing risk and hedging. We will talk about derivatives more in our next article.

All in all, we live in a time where we need to re adapt to our economies again and again. Reflecting back in history, we can learned numerous ways to avoid or minimise the risk of bubbles growing. But how many are willing to do that. We maybe living in a time where history is going to be made again. After all, there is no bubble that was formed, it is the insanity in us.

Renomic

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