The difference between a bubble and a cycle

1. According to various media sources we now have at least 14 bubbles: (as on Oct 2016)

A new real estate bubble.
A bond bubble.
A tech bubble.
A VC bubble.
A startup bubble.
A stock bubble.
A shale oil bubble.
A healthcare bubble.
A dollar bubble.
A college tuition bubble.
A Canadian housing bubble.
A central bank bubble.
A social media bubble.
A China bubble.

2. There is no official definition of a bubble. Anyone can define one.

3. Robert Shiller in his book Irrational Exuberance tried to define.

4. He says spotting a bubble is like diagnosing mental illness.

“The American Psychiatric Association’s diagnostic and statistical manual, which defines mental illness, consists of a checklist of symptoms” he once said.

He used this as a template to come up with his own checklist of bubble symptoms:

Rapidly increasing prices. (or "Madness" as Ramdeo Agarwal said about 1990-92 Harshad Mehta bull run)
Popular stories that justify the bubble.
Popular stories about how much money people are making.
Envy and regret among those sitting out.
Cheerleading by the media.
It’s so simple, and so smart.

But it’s far from perfect. Just as someone in a bad mood isn’t necessarily depressed, a lot of assets can give off the scent of a bubble without actually being one.

5. "My favorite example of this is Microsoft in the early 1990s.

Shares tripled from 1988 to early 1990.
People were telling stories about how computers would change the world. Bill Gates was celebrated on magazine covers as one of the youngest billionaires of all time.

Then, after years of hype, shares fell 31% in the middle of 1990.

It checked every box of being a classic bubble, down to the crushing loss of losing a third of your money in a few months.

But Microsoft wasn’t a bubble in 1990. It wasn’t anything close.

Even if you start from the peak, shares increased six-fold over the next five years, and 74-fold over the next ten years.

It’s only obvious in hindsight, but shares were massively undervalued at a time when they looked like a clear-cut bubble.

We see this so often.

Was Amazon a bubble in 1999? It checked all the boxes, but it wasn’t. Shares are eight times higher today than they were back then.

Same with Facebook in in 2012, and
GM in 1960.

Was China a bubble in 2007? It looked like it, and then its economy hit a wall. But then it came roaring back just as fast. So who knows?"

6. Cycles are one of the most fundamental and normal parts of how markets work. They look like this:


This cycle is self-reinforcing,

because if assets didn’t get expensive they’d offer big returns,

and offering big returns attracts capital, which makes them expensive.

That’s why cycles are everywhere and we can never get rid of them.

7. To me a bubble is when this cycle breaks. I have my own definition: It’s only a bubble if return prospects don’t improve after prices fall.

That was true of a lot of dot-com stocks, which weren’t bargains after they fell 90% because there was still no tangible company backing them up. It was true of homes in the mid-2000s, because you stood no chance of enjoying a recovery if you were foreclosed on. It was true of Holland’s 1600s tulip bubble, as the entire idea that tulips had any value went up in smoke.

8. If you find an asset whose price looks expensive and is probably going to fall, you likely haven’t found a bubble. You’ve found capitalism. Excesses will correct, recover, and life will go on.

9. But that raises a question: If we know cycles are regular, why not try to get ahead of them by buying and selling before they turn?

Because regular does not mean predictable.

We can say, in hindsight, that you should have sold stocks in 1999 and repurchased them in 2002. We can say, in hindsight, that you should have gotten out of the market in 1929 and bought back in in 1932. But not one person in a million actually achieved this, which should make us question how feasible it is do it in the future. Look at the returns of macro hedge funds, which try to ride the ups and downs of cycles and bubbles. You would not wish them upon your worst enemy.

10. The investing world becomes a lot less scary when you view most booms and busts as cycles rather than bubbles. Will things ebb and flow, sometimes by a lot? Well, yeah. That’s what you signed up for as an investor. But is everything with a valuation above its historic average a civilization-shattering bubble? Not by a long shot.

http://www.collaborativefund.com/blog/the-difference-between-a-bubble-and-a-cycle/?curator=alphaideas&utm_source=alphaideas