by Tom Copeland

Created on: September 27, 2010   Last Updated: September 29, 2010

Understanding the chemistry that fuels stock market bubbles is a difficult and complex study that even risk aversion professionals have a hard time grasping. So I wondered, is there any chance that we as first-time or even some of the seasoned retail investors can anticipate or predict, with even the most modest certainty, when and how these investment and asset bubbles will pop in the future?

I think the answer is no, not really. I do, however, believe that with just a little diligent effort in analyzing the patterns of previous bubbles, perhaps we can at least avoid them. Let’s face it; bubbles not only exist and contributed almost first-handedly to the Great Recession and the financial crisis of 2008, but the phenomenon will continue and is almost guaranteed to happen again – maybe even sooner rather than later.

Let’s start by looking at some of the US history’s biggest pops and use the knowledge and lessons learned in applying them to our hunt for today’s stock market or asset bubble.

Two bubbles for the price of one
Unquestionably, the most devastating, and perhaps until recently the most infamous stock market crash of all time came between the months of September and November of 1929, when the DOW nose-dived from roughly 380 to 200 points, cleaning and slicing off about 50%.

 But what’s “conveniently forgotten”, says Michael Bordo, Professor of Economics, and Director at the Center for Monetary and Financial History, Rutgers University, in a presentation called the Great Depression and the New Deal “is that over the next several months, from early November 1929 until sometime in the middle of April 1930, the Dow Jones average went up almost to 300 points again”.

That seems fine and dandy, until the newly created U.S. Federal Reserve decided to reel itself off the gold standard while the rest of the public was still knee-deep in a love affair with the precious metal. The result, many scholars and economists who study the events will argue was a world-wide boom in demand and squeeze in supply for gold, bank liquidity; and the Great Depression, during which the Dow Jones sank back down to 42 points by July of 1932.

One lesson I would like to take away from here is that before, during, and after the catastrophic financial events of the 30’s, gold has been widely considered a safe, hard asset to invest in during  aneconomic crisis.

The smartest bubble ever
What do the words, “Pets.com”

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