Tan Kin Lian's Blog: How to identity a bubble

Wednesday, January 14, 2009

How to identity a bubble

Someone asked, "How to identify a bubble?"

The answer: "Nobody knows". Alan Greenspan, the former chairman of the US Federal Reserve Board said that one knows a bubble after it has burst. This is not helpful. It turned out to be disastrous, as the bursting of the US housing bubble has led to the global financial crisis.

Is there a rule of thumb to identify a bubble? Nobody has dared to stick out his thumb. But I shall try.

You get a bubble when the current price is 50% or 100% higher than the average price for the past 5 years. Maybe, we should look at the actual statistics and see if 50% or 100% is a better indicator.

For example, the average oil price during the past 5 years prior to 2008 must be around US$40. When it exceeded US$80, it was a bubble. After it burst, it returned to US$40.

When the high end property prices in Singapore doubled in value in 2008 compared to the past years, it was a bubble. It burst soon after.

7 comments:

Anonymous said...: Dear Mr. Tan

I am afraid I will have to correct you on what is a bubble.

In Supply and Demand, a bubble is created when there is over supply and under demand.

In oil, there is a situation of under supply and over demand. Under supply being the depleting oil fields and inventories around the world currently. Over demand due to 2 developing economies with 2 billion population combined and that are playing a catching up chase toward middle class level as in the west.; January 14, 2009 3:04 PM
Tan Kin Lian said...: Dear TYP

It should be the other way round. A bubble occurs then there is over demand and inadequate supply.

The over demand is usually used by speculation and not real demand. This lead to a bubble.

When too many people wanted to buy properties, because they think that the price will continue to go up, their demand causes the bubble.; January 14, 2009 3:55 PM
Concerned said...: Bubbles occur when there is excessive speculation. People usually has a feel that there is a bubble, when they are in the midst of a bubble, but refuse to recognise it and get out because the winning feeling is so good. Bubbles are caused by excessive greed and investors become too confident and ignore the fundamentals. When the Shanghai Index was over 6,000 many investors knew there was a bubble, but they believe in the 'greater fool theory' and refuse to pull out, hoping to catch the last gush of winnings. It is easier to see a bubble from the outside than from the inside, i.e. when you have some investment you tends to hope that your investment will continue to flourish and brings you greater winnings, but when you have no investment on the table, you will have a neutral view of the market and can identify the bubbles more easily.; January 14, 2009 5:24 PM
Anonymous said...: Is the bubble-deflate V,U,L or inverted V,U, L?

For instance some report in TODAY (14.1.09) mentioned Singapore is going for a very severe recession this year but recovery will also be very fast. That means a V.

Like that quite OK what, even for bubbles. Just suffer a short, sharp pain and after that very fast comfortable again.; January 14, 2009 9:53 PM
Anonymous said...: I agree with Concerned. A bubble is always associated with big speculation. If there is only demand that push up the price of a certain commodity, without a lot of speculation, the price will remain firm. But producers may also speculate that the demand continues and hence produce more than required. This may also create a bubble.; January 14, 2009 10:35 PM
Jeremy said...: HBD prices are definitely in a bubble then!; January 15, 2009 12:33 AM
Anonymous said...: Bubble are cause by people who are in the irrational exuberance and are kiasu they might missed the boat if they do not get into the market; January 15, 2009 5:17 PM