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Thoughts from the Frontline

Bubbles, Bubbles Everywhere

November 1, 2013

(Note to readers: A small number of readers reported receiving a blank email of today's Thoughts from the Frontline, and so we decided to resend the letter in order to ensure that all readers were getting it.)

The difference between genius and stupidity is that genius has its limits.
– Albert Einstein

Genius is a rising stock market.
– John Kenneth Galbraith

Any plan conceived in moderation must fail when circumstances are set in extremes.
– Prince Metternich

You can almost feel it in the fall air (unless you are in the Southern Hemisphere). The froth and foam on markets of all shapes and sizes all over the world. It is an exhilarating feeling, and the pundits who populate the media outlets are bubbling over with it. There is nothing like a rising market to help lift our mood. Unless of course, as Prof. Kindleberger famously cautioned (see below), we are not participating in that rising market. Then we feel like losers. But what if the rising market is … a bubble? Are we smart enough to ride and then step aside before it bursts? Research says we all think that we are, yet we rarely demonstrate the actual ability.

This week we'll think about bubbles. Specifically, we'll have a look at part of the chapter on bubbles from my latest book, Code Red, which we launched last week. At the end of the letter, for your amusement, is a link to a short video of what you might hear if Jack Nicholson were playing the part of Ben Bernanke (or Janet Yellen?) on the witness stand, defending the extreme measures of central banks. A bit of a spoof, in good fun, but there is just enough there to make you wonder what if … and then smile. Economics can be so much fun if we let it.

I decided to use this part of the book when numerous references to bubbles popped into my inbox this week. When these bubbles finally burst, let no one exclaim that they were black swans, unforeseen events. Maybe because we have borne witness to so many crashes and bear markets in the past few decades, we have gotten better at discerning familiar patterns in the froth, reminiscent of past painful episodes.

Let me offer you three such bubble alerts that came my way today. The first is from my friend Doug Kass, who wrote:

I will address the issue of a stock market bubble next week, but here is a tease and fascinating piece of data: Since 1990, the P/E multiple of the S&P 500 has appreciated by about 2% a year; in 2013, the S&P's P/E has increased by 18%!

Then, from Jolly Olde London, comes one Toby Nangle, of Threadneedle Investments (you gotta love that name), who found the following chart, created a few years ago at the Bank of England. At least when Mervyn King was there they knew what they were doing. In looking at the chart, pay attention to the red line, which depicts real asset prices. As in they know they are creating a bubble in asset prices and are very aware of how it ends and proceed full speed ahead anyway. Damn those pesky torpedoes.

Toby remarks:

This is the only chart that I’ve found that outlines how an instigator of QE believes QE’s end will impact asset prices. The Bank of England published it in Q3 2011, and it tells the story of their expectation that while QE was in operation there would be a massive rise in real asset prices, but that this would dissipate and unwind over time, starting at the point at which the asset purchases were complete.

Oh, dear gods. Really? I can see my friends Nouriel Roubini or Marc Faber doing that chart, but the Bank of England? Really?!?

Then, continuing with our puckish thoughts, we look at stock market total margin debt (courtesy of those always puckish blokes at the Motley Fool). They wonder if, possibly, maybe, conceivably, perchance this is a warning sign?

And we won’t even go into the long list of stocks that are selling for large multiples, not of earnings but of SALES. As in dotcom-era valuations.

We make the case in Code Red that central banks are inflating bubbles everywhere, and that even though bubbles are unpredictable almost by definition, there are ways to benefit from them. So, without further ado, let’s look at what co-author Jonathan Tepper and I have to say about bubbles in Chapter 9.

Easy Money Will Lead to Bubbles and How to Profit from Them

Every year, the Darwin Awards are given out to honor fools who kill themselves accidentally and remove themselves from the human gene pool. The 2009 Award went to two bank robbers. The robbers figured they would use dynamite to get into a bank. They packed large quantities of dynamite by the ATM machine at a bank in Dinant, Belgium.…

Discuss This


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Nov. 4, 2013, 10:52 p.m.

What no-one seems to touch on is the ever increasing housing bubble in China! When that one pops, the whole world is going to feel it becaquse the Chinese are going to call in their U.S. loans which will set off a world-wide recession! It will be ugly! Get your financial houses in order because 2014 is going to be a doozy.

Richard Davis

Nov. 4, 2013, 3:41 a.m.

At the risk of sounding like a “puckish bloke” I need to comment on the Motley Fool chart showing the internet and housing bubbles.  When they publish this chart 12-18 months from now, the current peak will be called the Social Media Bubble.

TWTR is due to IPO on Nov 15.  FB rolled over after its earnings call. LNKD has dropped as well. I think that the bloom is already off the rose for Social Media, and the TWTR IPO may be the catalyzing event for popping the current bubble. 

During the dotcom heyday, everyone was preoccupied with hit counts and the “new economy” and forgot that if the number of consumers remained relatively constant, the amount of goods and services sold would remain relatively constant as well.

Today, everything I read and hear is “what is your company’s social media strategy?” as if a company’s tweets are more crucial than producing quality goods and services. 

In fact, take any headline from the late 1990’s and replace the word “internet” with “social media” and you will find little difference from current headlines.

Kenneth Cory

Nov. 3, 2013, 5:46 p.m.

I second the comment re John Mauldin’s ability to dumb down a subject as vast and incomprehensible to mundane mind as this article. 

To demonstrate that I learned something from it, please allow me to reveal to you the significance of your last comments about feeling in overwhelm as you attempt to grapple with the celebrity of a full emailbox, a busy business schedule, and doctor’s visits, adding into the mix iron-pumping routines and human pretzel yoga routines.  You have simply reached the delusion stage of the mania phase (see Figure 9.8) of the particular bubble we call success.  Not to worry—you won’t have to keep it up for long . . .

May I not be a prophet, and may you continue to shed the warm light of sense into this fogbank of an economy.

Shawn Allen

Nov. 3, 2013, 4:42 a.m.


Excellent question from Brett Darken. People throw around the statement that stocks are not real assets. Why not? when they represent ownership of productive real assets.

The whole concept of real assets is probably idiotic and CERTAINLY has done much damage as fools bought gold, at the peak, on that basis.

Shawn Allen

Nov. 3, 2013, 4:39 a.m.

MONEY versus Wealth

Perhaps John could address money supply versus wealth. Welkath vastly exceeds Mooney supply. Wealth is MEASURED in money. All money is wealth. All wealth is not money. A house is not money as such. It is worth money.

Shawn Allen

Nov. 3, 2013, 4:36 a.m.


I am with Ned Williams above. The common description that excess money supply flows into stocks is misleading as to what happens. As Ned says when one buys another must sell, money passes through markets it does not reside in markets.

The actual mechanism is more that additional money supply is manifested as easier ability to borrow. Fed buys bonds from banks leaving banks with cash that they wish to lend. Easier borrowing allows the prices of everything and especially assets to be bid up. The money does not go into stocks but additional loans do allow stock prices to be bid up.

Olen Lacy

Nov. 3, 2013, 3:46 a.m.

(As an aside, all you need to know about the Nobel Prize in Economics is that Minsky, Kindleberger, and Schumpeter did not get one and that Paul Krugman did.)

That was rather a cheap shot, John.  I’m disappointed.


Jane Axtell

Nov. 2, 2013, 9:02 p.m.

Chatting with friends we are puzzled by the persistent steadiness of the stock market under extreme conditions. If the underpinnings are falling apart, yet prices hold, is this a disguised bubble? When the larger players dare not sell that there are so few retain investors managing their own money, what do the prices mean?

Ivor Goodbody

Nov. 2, 2013, 8:18 p.m.

“The difference between genius and stupidity is that genius has its limits.
– Albert Einstein”

A pleasing quip. But not Einstein’s.

“Not everything that can be counted counts, and not everything that counts can be counted.”

Wikiquote says of this attributed remark: “From William Bruce Cameron’s Informal Sociology: A Casual Introduction to Sociological Thinking (1963), p. 13. The comment is part of a longer paragraph and does not appear in quotations in Cameron’s book, and other sources such as The Student’s Companion to Sociology (p. 92) attribute the quote to Cameron.

“A number of recent books claim that Einstein had a sign with these words in his office in Princeton, but until a reliable historical source can be found to support this, skepticism is warranted. The earliest source on google books that mentions the quote in association with Einstein and Princeton is Charles A. Garfield’s 1986 book Peak Performers: The New Heroes of American Business,p. 156…”

Wishing you enduring health (and full flexibility in your yoga class)


Doug Pedersen

Nov. 2, 2013, 5:59 p.m.

A good article, thanks.

A few points: first, the margin debt chart suffers from a few weaknesses.  The margin debt chart would be far more interesting if it went back another few decades.  Given the impact of credit cycles on asset prices and economic activity, it makes sense that swings in the speculative end would have outsized impact, particurly on equity prices.  It would be interesting to look at this back to the 1970s.  A second point would be - what is the causal relationship?  Does reigning in of margin start the top of prices, or is it the fall of prices which causes margin debt to be liquidated? 

However, there may be less than meets the eye, because, margin debt is a nominal liability, so in a world of inflation, it will rise over time.  True, so long as cyclical variations tightly map to equity price performance, it is something to monitor.  But the chart (perhaps the Motley Fool, whence it came) chose to draw a horizontal trend line, as though to say “we have passed the breaking point”.  But this line should be upward sloping given the fact that prices are also upward sloping.  In which case, we may well be far from the limit. (2 years, in my estimate).

A second point - you make a caveat about gold.  I chuckle.  The argument that gold prices responded naturally to changes in inflation expectations belies the fact that from 1982-2001 prices rose, and gold fell.  If gold were such a great inflation hedge, it should have continued to rise.  To argue that 850 was not a bubble because prices corrected when expectations changed is like saying NASDAQ 5000 wasn’t a bubble because it corrected after expectations for internet firms changed.

Finally, it iw worth noting that people like Ed Easterling have a credible explanation for high P/Es that have to do with inflation, and suggests that stock, at least, are modestly overvalued (but hardly in bubble territory) due to low inflation and low inflation expectations.