In the history of the financial markets, we have experience possibly hundreds of bubbles, from the tulip bubble all the way to the recent Web 2.0 bubble. The question is, how to you spot the top of the bubble, and get out before it’s too late? Truth is, it’s impossible to catch the top. Near the end of a bubble investors are in a maniac demeanor, hence it’s impossible to predict how long and how far the bubble can keep going. Just because the markets are in a bubble doesn’t mean they’re anywhere near the top of the bubble. However, here are some FUNDAMENTAL signs to watch out for.
- “This time is different”. Almost everyone gets caught in the bubble. That’s why bubble’s are usually blown sky high, into unseen before territory. Of course, there is no such thing as “this time is different”. We’ve all known that by now.
- Mega-corporate acquisitions. It’s usually near the end of the bubble that you hear about companies being snapped up by larger ones every day. This is because near the top of a bubble, corporate executives get the notion that they’re never going to run out of cash! If so, then why not buy any company in sight? Of course, when the stock market bubble crashes, this notion will be destroyed. But when you hear of companies like Tim Warner buying bought by AOL, that should ring a lightbulb.
- Contrarian indicators start buying. A well known contrarian indicator is Barron’s. For some reason, they always tell people to buy a certain investment just near the peak of the bubble.
- Companies begin buying up a whole bunch of useless crap, acting as if there’s no tomorrow.
- The public has turned blind to any fundamental or technical signals. As stated in the chart above (top of this post), the public tends to buy in the last stage of the bubble. But it’s near the very peak where the public no longer takes into consideration any fundamentals nor technical indicators, and engages in reckless buying.
- Major financial firms and analysts are proclaiming that “this is a once in a lifetime buying opportunity!” Of course, it isn’t. It’s a once in a lifetime buying opportunity if you want to lose money. Wall Street tends to crank out words of advice that the public wants to hear, not what the public needs to here. In a bubble, the public loves to hear words like “Dow 30k! Stocks are going up forever! etc.”
- Hedge funds are forming by the hundreds every month. The peak of a bubble is the time when all those hedge fund wanna-bes start forming their hedge funds, because with everyone feeling so rich, it becomes extremely easy to give away a few thousand or million dollars to the next self-proclaimed George Soros. And of course all these new hedge funds start investing in the industry that’s experiencing a bubble.
- You start hearing about the industry on TV and in the movies.
- Celebrities start endorsing the bubble.
Remember that without technical analysis, it’s almost impossible to predict the top of a bubble. But I’ve mentioned above a few guidelines that you should follow. I, on the other hand, have never attempted to pick the top of a bubble and short sell it. Too dangerous.