Hello readers
I hope you are all fine and healthy.
Bulls make money, bears make money, pigs get slaughtered.
-An old investment industry saying warns against being
excessively greedy.
So, it is weekend time to blog! Of late, my genres have been more on values, friendship, behavioural psychology, and some good vibes about entrepreneurship.
Today it is about one of my favorite topics, which I am pretty sure there are many people around who get excited and curious to understand about it. So, the stock market it is!
There is a lot of talks going on since last week about this jargon since past week.
It is called the “stock market bubble” lets break it up we know the stock market, what is a? A small globule typically hollow and light: such as. a: a small body of gas within a liquid. b: a thin film of liquid inflated with air or gas.
Understanding Stock Market Bubble
The Reserve Bank of India (RBI) recently warned about a possible stock market bubble in its annual report for FY21. The central bank’s comment comes on the back of domestic stock markets touching record highs even as the country’s economy continues to face disruption due to the second wave of the Covid-19 pandemic.
In the context of financial or economic markets, a bubble generally refers to a situation where the price of a stock, financial asset, an asset class, or an entire sector exceeds the fundamental value by a significant margin.
Stock market bubbles are usually hard to predict, especially for those who do not track the market in-depth daily.
There are usually five stages to a financial or asset bubble, and understanding each stage is essential to avoid wealth erosion. The five steps are displacement, boom, euphoria, profit-taking, and panic.
Simply put, the bubble is created based on speculative optimism or demand rather than the financial asset’s real or fundamental worth.
When the bubble bursts, it leads to massive selloffs, and prices decline rapidly.
The housing bubble in 2008 that led to a severe global recession is one of the most prominent examples, though there have been more minor instances in the past.
The bubble can affect the overall stock market, exchange-traded
funds (ETFs) or shares in a particular sector.
Rest assured; is not the first time this phenomenon has occurred ; here are some famous stock market bubbles which the markets have witnessed.
The Mississippi bubble (1719-1720)
The Mississippi Bubble -- which derives its name from the French Mississippi Company -- grew out of France’s dire economic situation in the early 18th century. By Louis XIV’s death in 1715, the treasury was in shambles, with the value of metallic currency fluctuating wildly.
The south sea bubble (1720)
During the same period that French speculators were driving up the price of shares in the Mississippi Company, English speculators were purchasing stock in the South Sea Company. Formed in 1711 by Robert Harley, the South Sea Company was created to convert £10 million of government war debt (incurred during the War of Spanish Succession) into its own shares. In exchange, the company would receive annual interest payments from the government and a monopoly on trade with the South Seas and South America.
The Japanese “bubble economy” (1984-1989)
From the 1960s to the 1980s, Japan had one of the highest economic growth rates in the world. In the 1970s, the government began to deregulate financial markets, which allowed banks to actively seek out new customers. During the mid-1980s, Japan took a loose approach to monetary policy, which caused the money supply to increase and interest rates to fall. Combining these two actions was essential to creating a speculative bubble: with low interest rates and easier access to credit, new actors entered the financial markets.
Recently the 2008 mortgage crash!
Are bubble bursts suitable for the market and its participants?
- Investors can benefit
from bubbles by being contrarian.
A bubble will typically result in great scrutiny on one or two market areas, leaving others ripe for the picking. Despite the broad brush that companies that operate in the sector get painted with, there are some excellent companies that long-term investors can target.
The two most significant traits to succeed in investing have the
mindset that allows an investor to be comfortable going against the tide and
waiting for their thesis to play out.
- The best way for
investors to differentiate between a new business and a trend is to do
their homework.
They should consider whether the business they are analyzing has
earnings. A company may not necessarily be profitable if it is reinvesting
heavily into its operations to grow its business. Still, the company needs to
demonstrate an ability to generate profits at some point in the future.
- Investors need to
evaluate how much they are paying for a business.
Paying 30, 40, or 50-times earnings is generally not a recipe
for success, as a great company can be a bad investment if bought at too high a
price. Sometimes, finding a great business means having to wait several years
before the market offers up the opportunity to buy it at an attractive price,
but that is part and parcel of being a disciplined investor.
- Investors need to
monitor their investments.
This is to ensure that the reason they bought a company in the first place is progressing as expected. Companies can fail to execute their strategies for various reasons, poor management, changing industry dynamics or sheer bad luck.
Some key takeaways which understood from doing my math and research are.
The bubble is an inevitable situation, just like the highs and lows of the market cannot be controlled.
It must be noted that day trading should keep a tab on the volatility and avoid trading on eccentric days, especially in derivatives, to avoid losing on heavy market premiums!
Finally, the positive part is that if the bubble fragments the market, and we see a double negative, it is the best time for long term investments.
Thanks a lot for your time, enjoy the rest of your evening.
Helios.
References:
https://www.indiatoday.in/business/story/rbi-warns-of-stock-market-bubble-should-investors-be-worried-1809096-2021-05-31
https://www.pbs.org/wgbh/pages/frontline/shows/dotcon/historical/bubbles.html
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