The Implications of Widespread ‘Bubble-Watching’

As contrarian investors, we should seek to oppose or avoid consensual modes of thinking (however dearly we hold them). So, in a market populated with increasing numbers of ‘bubble-watchers’, what’s a contrarian to do?


First of all, allow me to support my statement with some objective evidence. Please see the chart of the (financial) google searches for the word ‘bubble’ over the past seven years:


(Financial) Google Searches for 'Bubble'

Click to enlarge. Source: Google Insights


My personal contention is that this group of ‘bubble-watchers’ is already large. However, even if you have misgivings about this group’s size, it should be evident that it is growing (see chart). Can you blame them? After all, we’ve (potentially) had ‘bubbles’ in TMT, real estate, oil, the Dow, junk bonds etc. all in the past decade. Is it any wonder that people call every price-rise a ‘bubble’ these days? Furthermore, there has been an abundance of people who have missed these ‘bubbles’, and are desperate to catch/call the next one.


Herding is dangerous in the endeavor of financial speculation irrespective of its form. Therefore, even when great skepticism arises, we should be fearful of it and seek to avoid or oppose it in our trades. In my mind, throwing-over principles is part of the game. Consider that prior to 2000 (especially), ‘bubble-watching’ could have been a great context for thinking about markets. You could ride the upswings and avoid (or profit from) the downward twists. However, it was a good method precisely because it was the antithesis of consensual thinking. For whatever reasons, the majority of investors loved to buy and hold no matter what.


The Rise of Fickleness & The Fall of Obstinance:


One implication of the increasing prevalence of ‘bubble-watching’ is that the group of people who were obstitnantly long (the stock market) have been replaced with people that are – supposedly – aware of the transient nature of price rises. Crudely put; people get that it’s no good, but think they’ll get paid for going along with it for a while. Contrast this with the volume of investors who steadfastedly believed in the ‘inevitable’ long-term trend in the stock-market pre-2008. To them, dollar-cost averaging was king and market stress was made to be bought. It was the prevalence of such obstinance that allowed bubble-watchers to get out in time (pre-2000/pre-2008). After all, what was the knee-jerk reaction to periods of market stress? Buy and hold: don’t sell, else you’ll look like a fool! It has taken a decade of twists and turns to shake these beliefs, but as ever, the market cannot pay everyone and these changes in beliefs – en masse – will frustrate people rather than help them.


What this means for the contrarian investor:


The greatest implication I see is that many obstinate buyers have gone. Or at least, they’re going. They’re being replaced by people intent on riding the waves. The implications of this are rather interesting. For it brings a powerful self-sustaining element to downtrends; each downtrend has the potential to induce more market participants to decide that the ‘bubble’ is over. I contend that – in this environment – the potential for cascading sell orders is greatly elevated.


As the great Paul Tudor Jones noted in the 1980s documentary ‘Trader’ (pre ’87 crash):


… there will be a point in time, unquestionably, when the market turns down, when the investment community  - almost at once  - will say ‘that may have been the top’ or ‘this was the top’. And you’re going to have all the people that are very comfortably invested – that are believing in feeding off the hope that the market will move higher – try to get out at the same time. When that happens it’s going to be the famous Acapulco cliff dive. Just a question of how long until we hit the bottom.


Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression


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Posted Mar 14, 2011