Asset Bubble


What is an Asset Bubble?

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An asset bubble is a situation, in which there is a dramatic rise in the price of the asset over a short period of time not supported by the fundamentals, and is solely based on the beliefs and misconceptions. As the price doesn’t align with the fundamentals of the asset, the rapid increase in the price of the asset is followed by a quick decrease in the value which is referred to as the bubble burst.

The economist Hyman Minsky, broke down the life of the bubble into 5 stages.

  • Displacement
  • Price Boom
  • Euphoria
  • Profit - Taking
  • Panic

Let’s look into the stages in detail.

  1. Displacement:This occurs when investors start to get captivated by a new product or technology. The asset gradually becomes more and more popular among experienced investors.
  2. Price Boom: As the popularity of asset spreads in the market even the less experienced investor shows interest in the asset. Limited supply and lot of demand results in a surge in the price of the asset unwarranted by the fundamentals.
  3. Euphoria: Investors become enthusiastic over buying the asset. Prices grow so sharp that the asset receives attention among regular people. Even media highlights the asset in News, and you can hear about it in casual conversations. At this point, the enthusiasm turns into greed, and people who know nothing about the asset would be interested in buying it.
  4. Profit-Taking: In this phase, the prices will be at a peak. Investors start to realize that the asset is not worth the price and starts selling.
  5. Panic: Investors lose confidence in the asset. This is the stage of complete fear. And when no more investors are willing to buy the asset at the elevated price, a massive sell-off occurs, resulting in a plunge in the asset price.

Following are few asset bubbles in global history,

  • The Dutch Tulip Bubble
  • South Sea Company bubble
  • US housing bubble
  • Dot-com bubble
  • Japan's Real Estate and Stock Market Bubble
  • Global stock market bubble, or Black Monday
  • Cryptocurrency bubble

In the present situation, some analyst has expressed their view on the Gold as an asset bubble. They think that the price of Gold has gotten disconnected from fundamentals.

What should you do to protect yourself from Asset Bubbles? During the bubbles often, the price will keep increasing for years. The problem is that it is tough to time the asset bubbles and their subsequent burst.

“Diversification of your portfolio is the key to protect you from the asset bubbles to an extent.” Diversification means a balanced mix of asset classes in your portfolio. If there is a bubble in one of the asset classes of your portfolio, it will drive up the percentage you have in that asset class. So you have to revisit your asset allocation occasionally to make sure that it is still balanced.



Written by:
prashanth
Prashanth Prabhu, Founder & Principal Investment Adviser – 29k Group


Published by:
sheren
Ramya Gurram, Para Planner – 29k Investment Advisers Pvt. Ltd